ANNUAL REPORT
2015
I
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2015
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-10537
Delaware
(State of Incorporation)
36-3143493
(IRS Employer Identification Number)
37 South River Street, Aurora, Illinois 60507
(Address of principal executive offices, including zip code)
(630) 892-0202
(Registrant's telephone number, including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Class
Common Stock, $1.00 par value
Preferred Securities of Old Second Capital Trust I
Name of each exchange on which registered
The Nasdaq Stock Market
The Nasdaq Stock Market
Securities registered pursuant to Section 12(g) of the Act:
Preferred Share Purchase Rights
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports)
and (2) has been subject to such filing requirements for the past 90 days.
Yes No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files).
Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by Reference in Part III of
this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller
reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2
of the Exchange Act.
Large accelerated filer
Non-accelerated filer
Accelerated filer
Smaller reporting company
(Do not check if smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).
Yes
No
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, on June 30, 2015, the
last business day of the registrant’s most recently completed second fiscal quarter, was approximately $187.2 million. The number of
shares outstanding of the registrant's common stock, par value $1.00 per share, was 29,483,429 at March 8, 2016.
OLD SECOND BANCORP, INC.
Form 10-K
INDEX
PART I
Item 1
Business
Item 1A Risk Factors
Item 1B Unresolved Staff Comments
Item 2
Properties
Item 3
Legal Proceedings
Item 4
Mine Safety Disclosures
PART II
Item 5
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6
Selected Financial Data
Item 7
Management's Discussion and Analysis of Financial Condition and Results of Income
Item 7A Quantitative and Qualitative Disclosures about Market Risk
Item 8
Financial Statements and Supplementary Data
Item 9
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A Controls and Procedures
Item 9B Other Information
PART III
Item 10
Directors, Executive Officers, and Corporate Governance
Item 11
Executive Compensation
Item 12
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13
Certain Relationships and Related Transactions, and Director Independence
Item 14
Principal Accountant Fees and Services
PART IV
Item 15
Exhibits and Financial Statement Schedules
Signatures
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19
26
26
26
26
27
29
29
43
45
86
86
89
89
89
89
90
90
90
91
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Item 1. Business
General
Old Second Bancorp, Inc. (the "Company" or the "Registrant") was organized under the laws of Delaware on September 8, 1981. It is a
registered bank holding company under the Bank Holding Company Act of 1956 (the "BHCA"). The Company's office is located at 37
South River Street, Aurora, Illinois 60507.
The Company conducts a full service community banking and trust business through the following wholly owned subsidiaries, which
together with the Registrant are referred to as the “Company”:
Old Second National Bank (the “Bank”).
Old Second Capital Trust I, which was formed for the exclusive purpose of issuing trust preferred securities in an offering that
was completed in July 2003.
Old Second Capital Trust II, which was formed for the exclusive purpose of issuing trust preferred securities in an offering
that was completed in April 2007.
Old Second Affordable Housing Fund, L.L.C., which was formed for the purpose of providing down payment assistance for
home ownership to qualified individuals.
A series of limited liability companies wholly owned by the Bank and formed between 2008 and 2012 to hold property
acquired by the Bank through foreclosure or in the ordinary course of collecting a debt previously contracted with borrowers.
River Street Advisors, LLC, a wholly owned subsidiary of the Bank, which was formed in May 2010 to provide investment
advisory/management services.
Inter-company transactions and balances are eliminated in consolidation.
The Company provides financial services through its 24 banking locations that are located primarily in Aurora, Illinois, and its
surrounding communities and throughout the Chicago metropolitan area. These locations included retail offices located in Kane,
Kendall, DeKalb, DuPage, LaSalle, Will and Cook counties in Illinois as of December 31, 2015.
Business of the Company and its Subsidiaries
The Bank’s full service banking businesses include the customary consumer and commercial products and services that banking
institutions provide including demand, NOW, money market, savings, time deposit, individual retirement and Keogh deposit accounts;
commercial, industrial, consumer and real estate lending, including installment loans, student loans, agricultural loans, lines of credit
and overdraft checking; safe deposit operations; trust services; wealth management services; and an extensive variety of additional
services tailored to the needs of individual customers, such as the acquisition of U.S. Treasury notes and bonds, the sale of traveler's
checks, money orders, cashiers’ checks and foreign currency, direct deposit, discount brokerage, debit cards, credit cards, and other
special services. The Bank also offers a full complement of electronic banking services such as online and mobile banking and
corporate cash management products including remote deposit capture, mobile deposit capture, investment sweep accounts, zero
balance accounts, automated tax payments, ATM access, telephone banking, lockbox accounts, automated clearing house transactions,
account reconciliation, controlled disbursement, detail and general information reporting, wire transfers, vault services for currency and
coin, and checking accounts. Commercial and consumer loans are made to corporations, partnerships and individuals, primarily on a
secured basis. Commercial lending focuses on business, capital, construction, inventory and real estate lending. Installment lending
includes direct and indirect loans to consumers and commercial customers. Additionally, the Bank provides a wide range of wealth
management, investment, agency, and custodial services for individual, corporate, and not-for-profit clients. These services include the
administration of estates and personal trusts, as well as the management of investment accounts for individuals, employee benefit plans,
and charitable foundations. The Bank also originates residential mortgages, offering a wide range of mortgage products including
conventional, government, and jumbo loans. Secondary marketing of those mortgages is also handled at the Bank.
Operating segments are components of a business about which separate financial information is available and that are evaluated
regularly by the Company’s management in deciding how to allocate resources and assess performance. Public companies are required
to report certain financial information about operating segments. The Company’s management evaluates the operations of the
Company as one operating segment, i.e. community banking.
Market Area
The Company’s primary market area is Aurora, Illinois and its surrounding communities. The city of Aurora is located in northeastern
Illinois, approximately 40 miles west of Chicago. The Bank operates primarily in Kane, Kendall, DeKalb, DuPage, LaSalle, Will and
Cook counties in Illinois, and it has developed a strong presence in these counties. The Bank offers its services to retail, commercial,
industrial, and public entity customers in the Aurora, North Aurora, Batavia, St. Charles, Burlington, Elburn, Elgin, Maple Park,
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Kaneville, Sugar Grove, Naperville, Lisle, Joliet, Yorkville, Plano, Wasco, Ottawa, Oswego, Sycamore, Frankfort, and Chicago
Heights communities and surrounding areas. During 2015 the Company closed one of two branches in Batavia.
Lending Activities
The Bank provides a broad range of commercial and retail lending services to corporations, partnerships, individuals and government
agencies. The Bank actively markets its services to qualified borrowers. Lending officers actively solicit the business of new
borrowers entering our market areas as well as long-standing members of the local business community. The Bank has established
lending policies that include a number of underwriting factors to be considered in making a loan, including location, amortization, loan
to value ratio, cash flow, pricing, documentation and the credit history of the borrower. In 2015, the Bank originated approximately
$430.8 million in loans. Also in 2015, residential mortgage loans of approximately $190.6 million (some of which were originated in
2014) were sold to third parties. The Bank’s loan portfolios are comprised primarily of loans in the areas of commercial real estate,
residential real estate, construction, general commercial and consumer lending. As of December 31, 2015, residential mortgages made
up approximately 31% (32% at year-end 2014) of the Bank’s loan portfolio, commercial real estate loans comprised approximately
53% (52% at year-end 2014), construction lending comprised approximately 2%, general commercial loans comprised approximately
12% (10% at year-end 2014), and consumer and other lending comprised less than 2%. It is the Bank’s policy to comply at all times
with the various consumer protection laws and regulations including, but not limited to, the Equal Credit Opportunity Act, the Fair
Housing Act, the Community Reinvestment Act, the Truth in Lending Act, and the Home Mortgage Disclosure Act.
Commercial Loans. The Bank continues to focus on growing commercial and industrial prospects in its new business pipeline with
positive results in 2015. As noted above, the Bank is an active commercial lender, primarily located west and south of the Chicago
metropolitan area and active in other parts of the Chicago and Aurora metropolitan areas. Commercial lending reflects revolving lines
of credit for working capital, lending for capital expenditures on manufacturing equipment and lending to small business
manufacturers, service companies, medical and dental entities as well as specialty contractors. The Bank also has commercial and
industrial loans to customers in food product manufacturing, food process and packing, machinery tooling manufacturing as well as
service and technology companies. Collateral for these loans generally includes accounts receivable, inventory, equipment and real
estate. In addition, the Bank may take personal guarantees to help assure repayment. Loans may be made on an unsecured basis if
warranted by the overall financial condition of the borrower. Commercial term loans range principally from one to eight years with the
majority falling in the one to five year range. Interest rates are primarily fixed although some have interest rates tied to the prime rate
or LIBOR. In 2015, the Bank closed a meaningful amount of fixed rate loans with terms longer than four years. While management
would like to continue to diversify the loan portfolio, overall demand for working capital and equipment financing continued to be
muted in the Bank’s primary market area in 2015.
Repayment of commercial loans is largely dependent upon the cash flows generated by the operations of the commercial enterprise.
The Bank’s underwriting procedures identify the sources of those cash flows and seek to match the repayment terms of the commercial
loans to the sources. Secondary repayment sources are typically found in collateralization and guarantor support.
Commercial Real Estate Loans. While management has been actively working to reduce the Bank’s concentration in real estate loans,
including commercial real estate loans, a large portion of the loan portfolio continues to be comprised of commercial real estate loans.
As of December 31, 2015, approximately $297.5 million, or 49.1% (50.3%, at year-end 2014) of the total commercial real estate loan
portfolio of $605.7 million was to borrowers who secured the loan with owner occupied property. A primary repayment risk for a
commercial real estate loan is interruption or discontinuance of cash flows from operations. Such cash flows are usually derived from
rent in the case of nonowner occupied commercial properties. Repayment could also be influenced by economic events, which may or
may not be under the control of the borrower, or changes in regulations that negatively impact the future cash flow and market values
of the affected properties. Repayment risk can also arise from general downward shifts in the valuations of classes of properties over a
given geographic area such as the ongoing but diminished price adjustments that have been observed by the Company beginning in
2008. Property valuations could continue to be affected by changes in demand and other economic factors, which could further
influence cash flows associated with the borrower and/or the property. The Bank attempts to mitigate these risks by staying apprised of
market conditions and by maintaining underwriting practices that provide for adequate cash flow margins and multiple repayment
sources as well as remaining in regular contact with its borrowers. In most cases, the Bank has collateralized these loans and/or has
taken personal guarantees to help assure repayment. Commercial real estate loans are primarily made based on the identified cash flow
of the borrower and/or the property at origination and secondarily on the underlying real estate acting as collateral. Additional credit
support is provided by the borrower for most of these loans and the probability of repayment is based on the liquidation value of the
real estate and enforceability of personal and corporate guarantees if any exist.
Construction Loans. The Bank’s construction and development lending and related risks have greatly diminished from prior periods
as the construction and development portfolio no longer dominates the Bank’s commercial real estate portfolio. Loans in this category
decreased from $44.8 million at December 31, 2014, to $19.8 million at December 31, 2015. The Bank uses underwriting and
construction loan guidelines to determine whether to issue loans on build-to-suit or build out of existing borrower properties.
Construction loans are structured most often to be converted to permanent loans at the end of the construction phase or, infrequently, to
be paid off upon receiving financing from another financial institution. Construction loans are generally limited to our local market
area. Lending decisions have been based on the appraised value of the property as determined by an independent appraiser, an analysis
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of the potential marketability and profitability of the project and identification of a cash flow source to service the permanent loan or
verification of a refinancing source. Construction loans generally have terms of up to 12 months, with extensions as needed. The Bank
disburses loan proceeds in increments as construction progresses and as inspections warrant.
Construction loans involve additional risks. Development lending often involves the disbursement of substantial funds with repayment
dependent, in part, on the success of the ultimate project rather than the ability of the borrower or guarantor to repay principal and
interest. This generally involves more risk than other lending because it is based on future estimates of value and economic
circumstances. While appraisals are required prior to funding, and loan advances are limited to the value determined by the appraisal,
there is the possibility of an unforeseen event affecting the value and/or costs of the project. Development loans are primarily used for
single-family developments, where the sale of lots and houses are tied to customer preferences and interest rates. If the borrower
defaults prior to completion of the project, the Bank may be required to fund additional amounts so that another developer can complete
the project. The Bank is located in an area where a large amount of development activity has occurred as rural and semi-rural areas are
being suburbanized. This type of growth presents some economic risks should local demand for housing shift. The Bank addresses
these risks by closely monitoring local real estate activity, adhering to proper underwriting procedures, closely monitoring construction
projects, and limiting the amount of construction development lending.
Residential Real Estate Loans. Residential first mortgage loans, second mortgages, and home equity line of credit mortgages are
included in this category. First mortgage loans may include fixed rate loans that are generally sold to investors. The Bank is a direct
seller to the Federal National Mortgage Association (“FNMA”), Federal Home Loan Mortgage Corporation (“FHLMC”) and to several
large financial institutions. The Bank typically retains servicing rights for sold mortgages. The retention of such servicing rights also
allows the Bank an opportunity to have regular contact with mortgage customers and can help to solidify community involvement.
Other loans that are not sold include adjustable rate mortgages, lot loans, and constructions loans that are held in the Bank’s portfolio.
Residential mortgage purchase activity has reflected a moderate level of activity as the real estate market in our market area continues
to stabilize. However, with continuing lower interest rates and increased stabilization in our market area, the Bank’s residential
mortgage lending reflects a steady volume and mixture of both refinance and purchase financing opportunities. Home equity lending
has continued to slow in the past year but is still a meaningful portion of the Bank’s business.
Consumer Loans. The Bank also provides many types of consumer loans including primarily motor vehicle, home improvement and
signature loans. Consumer loans typically have shorter terms and lower balances with higher yields as compared to other loans but
generally carry higher risks of default. Consumer loan collections are dependent on the borrower’s continuing financial stability and
thus are more likely to be affected by adverse personal circumstances.
Competition
The Company’s market area is highly competitive and the Bank’s business activities require it to compete with many other financial
institutions. A number of these financial institutions are affiliated with large bank holding companies headquartered outside of our
principal market area as well as other institutions that are based in Aurora's surrounding communities and in Chicago, Illinois. All of
these financial institutions operate banking offices in the greater Aurora area or actively compete for customers within the Company's
market area. The Bank also faces competition from finance companies, insurance companies, credit unions, mortgage companies,
securities brokerage firms, money market funds, loan production offices and other providers of financial services. Many of our
nonbank competitors are not subject to the same extensive federal regulations that govern bank holding companies and banks, such as
the Company, may have certain competitive advantages.
The Bank competes for loans principally through the quality of its client service and its responsiveness to client needs in addition to
competing on interest rates and loan fees. Management believes that its long-standing presence in the community and personal one-on-
one service philosophy enhances its ability to compete favorably in attracting and retaining individual and business customers. The
Bank actively solicits deposit-related clients and competes for deposits by offering personal attention, competitive interest rates, and
professional services made available through experienced bankers and multiple delivery channels that fit the needs of its market.
The Bank operated 24 branches in the seven counties of Kane, Kendall, LaSalle, Will, DeKalb, DuPage, and Cook County as of
December 31, 2015. The financial services industry will continue to become more competitive as further technological advances enable
more financial institutions to provide expanded financial services without having a physical presence in our market.
Employees
At December 31, 2015, 2014 and 2013, the Company employed 450, 485 and 492 full-time equivalent employees, respectively.
Management implemented a staff reduction program in 2015 that reduced staffing levels with related severance costs and subsequent
reductions in monthly compensation expenses. The Company places a high priority on staff development, which involves extensive
training, including customer service training. New employees are selected on the basis of both technical skills and customer service
capabilities. None of the Company's employees are covered by collective bargaining agreements.
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Internet
The Company maintains a corporate website at http://www.oldsecond.com. The Company makes available free of charge on or
through its website the Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after the
Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission (the “SEC”). Many of the
Company’s policies, committee charters and other investor information including our Code of Business Conduct and Ethics, are
available on the Company’s website. The Company’s reports, proxy and informational statements and other information regarding the
Company are available free of charge on the SEC’s website (www.sec.gov). The Company will also provide copies of its filings free of
charge upon written request to: J. Douglas Cheatham, Executive Vice President and Chief Financial Officer, Old Second Bancorp, Inc.,
37 South River Street, Aurora, Illinois 60507.
Forward-Looking Statements: This report contains forward-looking statements within the meaning of the Private Securities Litigation
Reform Act, including with respect to management’s expectations regarding future plans, strategies and financial performance,
regulatory developments, industry and economic trends, and other matters. Forward-looking statements are identifiable by the
inclusion of such qualifications as “expects,” “intends,” “believes,” “may,” “will,” “would,” “could,” “should,” “plan,” “anticipate,”
“estimate,” “possible,” “likely” or other indications that the particular statements are not historical facts. Actual events and results may
differ significantly from those described in such forward-looking statements, due to numerous factors, including:
negative economic conditions that adversely affect the economy, real estate values, the job market and other factors nationally
and in our market area, in each case that may affect our liquidity and the performance of our loan portfolio;
defaults and losses on our loan portfolio;
the financial success and viability of the borrowers of our commercial loans;
market conditions in the commercial and residential real estate markets in our market area;
changes U.S. monetary policy, the level and volatility of interest rates, the capital markets and other market conditions that
may affect, among other things, our liquidity and the value of our assets and liabilities;
competitive pressures in the financial services business;
any negative perception of our reputation or financial strength;
ability to raise additional capital on acceptable terms when needed;
ability to use technology to provide products and services that will satisfy customer demands and create efficiencies in
operations;
adverse effects on our information technology systems resulting from failures, human error or cyberattacks;
adverse effects of failures by our vendors to provide agreed upon services in the manner and at the cost agreed, particularly
our information technology vendors;
the impact of any claims or legal actions, including any effect on our reputation;
losses incurred in connection with repurchases and indemnification payments related to mortgages;
the soundness of other financial institutions;
changes in accounting standards, rules and interpretations and the impact on our financial statements;
our ability to receive dividends from our subsidiaries;
a decrease in our regulatory capital ratios;
legislative or regulatory changes, particularly changes in regulation of financial services companies;
increased costs of compliance, heightened regulatory capital requirements and other risks associated with changes in
regulation and the current regulatory environment, including the Dodd-Frank Act;
the impact of heightened capital requirements; and
each of the factors and risks identified under the heading “Risk Factors.”
Therefore, there can be no assurances that future actual results will correspond to these forward-looking statements. Additionally, all
statements in this Form 10-K, including forward-looking statements, speak only as of the date they are made, and the Company
undertakes no obligation to update any statement in light of new information or future events.
SUPERVISION AND REGULATION
General
FDIC-insured institutions, like the Bank, as well as their holding companies and their affiliates, are extensively regulated under federal
and state law. As a result, the Company’s growth and earnings performance may be affected not only by management decisions and
general economic conditions, but also by the requirements of federal and state statutes and by the regulations and policies of various
bank regulatory agencies, including the Office of the Comptroller of the Currency (the “OCC”), the Board of Governors of the Federal
Reserve System (the “Federal Reserve”), the Federal Deposit Insurance Corporation (the “FDIC”) and the Bureau of Consumer
Financial Protection (the “CFPB”). Furthermore, taxation laws administered by the Internal Revenue Service and state taxing
authorities, accounting rules developed by the Financial Accounting Standards Board, securities laws administered by the Securities
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and Exchange Commission (the “SEC”) and state securities authorities, and anti-money laundering laws enforced by the U.S.
Department of the Treasury (the “Treasury”) have an impact on the business of the Company and the Bank. The effect of these
statutes, regulations, regulatory policies and accounting rules are significant to the operations and results of the Company and the Bank,
and the nature and extent of future legislative, regulatory or other changes affecting financial institutions are impossible to predict with
any certainty.
Federal and state banking laws impose a comprehensive system of supervision, regulation and enforcement on the operations of FDIC-
insured institutions, their holding companies and affiliates that is intended primarily for the protection of the FDIC-insured deposits and
depositors of banks, rather than shareholders. These federal and state laws, and the regulations of the bank regulatory agencies issued
under them, affect, among other things, the scope of the Company’s and the Bank’s business, the kinds and amounts of investments
they may make, Bank reserve requirements, capital levels relative to assets, the nature and amount of collateral for loans, the
establishment of branches, the Company’s ability to merge, consolidate and acquire, dealings with insiders and affiliates and the Bank’s
payment of dividends. In the last several years, the Company and the Bank have experienced heightened regulatory requirements and
scrutiny following the global financial crisis and as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the
“Dodd-Frank Act”). Although the reforms primarily targeted systemically important financial service providers, their influence filtered
down in varying degrees to community banks over time, and the reforms have caused the Company’s compliance and risk management
processes, and the costs thereof, to increase.
This supervisory and regulatory framework subjects FDIC-insured institutions and their holding companies to regular examination by
their respective regulatory agencies, which results in examination reports and ratings that are not publicly available and that can impact
the conduct and growth of their business. These examinations consider not only compliance with applicable laws and regulations, but
also capital levels, asset quality and risk, management ability and performance, earnings, liquidity, and various other factors. The
regulatory agencies generally have broad discretion to impose restrictions and limitations on the operations of a regulated entity where
the agencies determine, among other things, that such operations are unsafe or unsound, fail to comply with applicable law or are
otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies.
The following is a summary of the material elements of the supervisory and regulatory framework applicable to the Company and the
Bank, beginning with a discussion of the continuing regulatory emphasis on capital levels. It does not describe all of the statutes,
regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described. The descriptions
are qualified in their entirety by reference to the particular statutory and regulatory provision.
Regulatory Emphasis on Capital
Regulatory capital represents the net assets of a banking organization available to absorb losses. Because of the risks attendant to their
business, FDIC-insured institutions are generally required to hold more capital than other businesses, which directly affects the
Company’s earnings capabilities. Although capital has historically been one of the key measures of the financial health of banks, its
role became fundamentally more important in the wake of the global financial crisis, as the banking regulators recognized that the
amount and quality of capital held by banks prior to the crisis was insufficient to absorb losses during periods of severe stress. Certain
provisions of the Dodd-Frank Act and Basel III, discussed below, establish strengthened capital standards for banking organizations,
require more capital to be held in the form of common stock and disallow certain funds from being included in capital
determinations. These standards represent regulatory capital requirements that are meaningfully more stringent than those in place
previously.
Minimum Required Capital Levels. Bank holding companies have historically had to comply with less stringent capital standards than
their bank subsidiaries and have been able to raise capital with hybrid instruments such as trust preferred securities. The Dodd-Frank
Act mandated that the Federal Reserve establish minimum capital levels for holding companies on a consolidated basis as stringent as
those required for FDIC-insured institutions. As a consequence, the components of holding company permanent capital known as “Tier
1 Capital” were restricted to those capital instruments that were considered Tier 1 Capital for FDIC-insured institutions. A result of this
change is that the proceeds of hybrid instruments, such as trust preferred securities, are being excluded from Tier 1 Capital over a
phase-out period. However, if such securities were issued prior to May 19, 2010 by bank holding companies with less than $15 billion
of assets, they may be retained, subject to certain restrictions. Because the Company has assets of less than $15 billion, the Company is
able to maintain its trust preferred proceeds as Tier 1 Capital but the Company has to comply with new capital mandates in other
respects and will not be able to raise Tier 1 Capital in the future through the issuance of trust preferred securities.
The capital standards for the Company and the Bank changed on January 1, 2015 to add the requirements of Basel III, discussed below.
The minimum capital standards effective prior to and including December 31, 2014 are:
A leverage requirement, consisting of a minimum ratio of Tier 1 Capital to total adjusted average quarterly assets of 3% for
the most highly-rated banks with a minimum requirement of at least 4% for all others, and
A risk-based capital requirement, consisting of a minimum ratio of Total Capital to total risk-weighted assets of 8% and a
minimum ratio of Tier 1 Capital to total risk-weighted assets of 4%.
For these purposes, “Tier 1 Capital” consists primarily of common stock, noncumulative perpetual preferred stock and related
surplus less intangible assets (other than certain loan servicing rights and purchased credit card relationships). Total Capital consists
primarily of Tier 1 Capital plus “Tier 2 Capital,” which includes other non-permanent capital items, such as certain other debt and
equity instruments that do not qualify as Tier 1 Capital, and the Bank’s allowance for loan losses, subject to a limitation of 1.25% of
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risk-weighted assets. Further, risk-weighted assets for the purpose of the risk-weighted ratio calculations are balance sheet assets and
off-balance sheet exposures to which required risk weightings of 0% to 100% are applied.
The Basel International Capital Accords. The risk-based capital guidelines described above are based upon the 1988 capital accord
known as “Basel I” adopted by the international Basel Committee on Banking Supervision, a committee of central banks and bank
supervisors, as implemented by the U.S. federal banking regulators on an interagency basis. In 2008, the banking agencies
collaboratively began to phase-in capital standards based on a second capital accord, referred to as “Basel II,” for large or “core”
international banks (generally defined for U.S. purposes as having total assets of $250 billion or more, or consolidated foreign
exposures of $10 billion or more). On September 12, 2010, the Group of Governors and Heads of Supervision, the oversight body of
the Basel Committee on Banking Supervision, announced agreement on a strengthened set of capital requirements for banking
organizations around the world, known as Basel III, to address deficiencies recognized in connection with the global financial
crisis. Because of Dodd-Frank Act requirements, Basel III essentially layers a new set of capital standards on the previously existing
Basel I standards.
The Basel III Rule. In July 2013, the U.S. federal banking agencies approved the implementation of the Basel III regulatory capital
reforms in pertinent part, and, at the same time, promulgated rules effecting certain changes required by the Dodd-Frank Act (the
“Basel III Rule”). In contrast to capital requirements historically, which were in the form of guidelines, Basel III was released in the
form of regulations by each of the regulatory agencies. The Basel III Rule is applicable to all banking organizations that are subject to
minimum capital requirements, including federal and state banks and savings and loan associations, as well as to bank and savings and
loan holding companies, other than “small bank holding companies” (generally bank holding companies with consolidated assets of
less than $1 billion which are not publically traded companies).
The Basel III Rule not only increased most of the required minimum capital ratios effective January 1, 2015, but it introduced the
concept of Common Equity Tier 1 Capital, which consists primarily of common stock, related surplus (net of treasury stock), retained
earnings, and Common Equity Tier 1 minority interests subject to certain regulatory adjustments. The Basel III Rule also expanded the
definition of capital by establishing more stringent criteria that instruments must meet to be considered Additional Tier 1 Capital (Tier
1 Capital in addition to Common Equity) and Tier 2 Capital. A number of instruments that qualified as Tier 1 Capital do not qualify, or
their qualifications will change. For example, noncumulative perpetual preferred stock, which qualified as simple Tier 1 Capital, does
not qualify as Common Equity Tier 1 Capital, but qualifies as Additional Tier 1 Capital. The Basel III Rule also constrained the
inclusion of minority interests, mortgage-servicing assets, and deferred tax assets in capital and requires deductions from
Common Equity Tier 1 Capital in the event that such assets exceed a certain percentage of a banking organization’s Common Equity
Tier 1 Capital.
The Basel III Rule requires minimum capital ratios beginning January 1, 2015, as follows:
A new ratio of minimum Common Equity Tier 1 equal to 4.5% of risk-weighted assets;
An increase in the minimum required amount of Tier 1 Capital to 6% of risk-weighted assets;
A continuation of the current minimum required amount of Total Capital (Tier 1 plus Tier 2) at 8% of risk-weighted assets;
and
A minimum leverage ratio of Tier 1 Capital to total adjusted average quarterly assets equal to 4% in all circumstances.
Not only did the capital requirements change but the risk weightings (or their methodologies) for bank assets that are used to determine
the capital ratios changed as well. For nearly every class of assets, the Basel III Rule requires a more complex, detailed and calibrated
assessment of credit risk and calculation of risk weightings.
Banking organizations (except for large, internationally active banking organizations) became subject to the new rules on January 1,
2015. However, there are separate phase-in/phase-out periods for: (i) the capital conservation buffer; (ii) regulatory capital adjustments
and deductions; (iii) nonqualifying capital instruments; and (iv) changes to the prompt corrective action rules. The phase-in periods
commenced on January 1, 2016 and extend until 2019.
Well-Capitalized Requirements. The ratios described above are minimum standards in order for banking organizations to be
considered “adequately capitalized” under the Prompt Corrective Action rules discussed below. Bank regulatory agencies uniformly
encourage banking organizations to hold more capital and be “well-capitalized” and, to that end, federal law and regulations provide
various incentives for such organizations to maintain regulatory capital at levels in excess of minimum regulatory requirements. For
example, a banking organization that is well-capitalized may: (i) qualify for exemptions from prior notice or application requirements
otherwise applicable to certain types of activities; (ii) qualify for expedited processing of other required notices or applications; and (iii)
accept, roll-over or renew brokered deposits. Higher capital levels could also be required if warranted by the particular circumstances
or risk profiles of individual banking organizations. Moreover, the Federal Reserve’s capital guidelines contemplate that additional
capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of
credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating
significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 Capital less all
intangible assets), well above the minimum levels.
Under the capital regulations of the OCC and Federal Reserve, in order to be well-capitalized, a banking organization must maintain:
A new Common Equity Tier 1 Capital ratio to risk-weighted assets of 6.5% or more;
A minimum ratio of Tier 1 Capital to total risk-weighted assets of 8% (6% under Basel I);
8
A minimum ratio of Total Capital to total risk-weighted assets of 10% (the same as Basel I); and
A leverage ratio of Tier 1 Capital to total adjusted average quarterly assets of 5% or greater.
In addition, banking organizations that seek the freedom to make capital distributions (including for dividends and repurchases of
stock) and pay discretionary bonuses to executive officers without restriction must also maintain 2.5% in Common Equity Tier 1
attributable to a capital conservation buffer to be phased in over three years beginning in 2016. The purpose of the conservation buffer
is to ensure that banking organizations maintain a buffer of capital that can be used to absorb losses during periods of financial and
economic stress. Factoring in the fully phased-in conservation buffer increases the minimum ratios depicted above to:
7% for Common Equity Tier 1,
8.5% for Tier 1 Capital and
10.5% for Total Capital.
It is possible under the Basel III Rule to be well-capitalized while remaining out of compliance with the capital conservation buffer.
As of December 31, 2015: (i) the Bank was not subject to a directive from the OCC to increase its capital and (ii) the Bank was well-
capitalized, as defined by OCC regulations. As of December 31, 2015, the Company had regulatory capital in excess of the Federal
Reserve’s requirements and met the Basel III Rule requirements to be well-capitalized.
Prompt Corrective Action. An FDIC-insured institution’s capital plays an important role in connection with regulatory enforcement as
well. This regime applies to FDIC-insured institutions, not holding companies, and provides escalating powers to bank regulatory
agencies as a bank’s capital diminishes. Federal law provides the federal banking regulators with broad power to take prompt corrective
action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution
in question is “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each
case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators’ corrective
powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting
its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to sell itself; (iv)
restricting transactions between the institution and its affiliates; (v) restricting the interest rate that the institution may pay on deposits;
(vi) ordering a new election of directors of the institution; (vii) requiring dismissal of senior executive officers or directors; (viii)
prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries;
(x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution.
Regulation and Supervision of the Company
General. The Company, as the sole shareholder of the Bank, is a bank holding company. As a bank holding company, the Company is
registered with, and subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the
“BHCA”). The Company is legally obligated to act as a source of financial and managerial strength to the Bank and to commit
resources to support the Bank in circumstances where it might not otherwise do so. The Company is subject to periodic examination by
the Federal Reserve and is required to file with the Federal Reserve periodic reports of its operations and such additional information
regarding its operations as the Federal Reserve may require.
Acquisitions, Activities and Change in Control. The primary purpose of a bank holding company is to control and manage banks. The
BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any
acquisition by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit
concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any
state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law
limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its FDIC-insured
institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state
institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of
time (not to exceed five years) before being acquired by an out-of-state bank holding company. Furthermore, in accordance with the
Dodd-Frank Act, bank holding companies must be well-capitalized and well-managed in order to effect interstate mergers or
acquisitions. For a discussion of the capital requirements, see “Regulatory Emphasis on Capital” above.
The BHCA generally prohibits the Company from acquiring direct or indirect ownership or control of more than 5% of the voting
shares of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks
or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal
exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the
Federal Reserve prior to November 11, 1999 to be “so closely related to banking ... as to be a proper incident thereto.” This authority
would permit the Company to engage in a variety of banking-related businesses, including the ownership and operation of a savings
association, or any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau
(including software development) and mortgage banking and brokerage services. The BHCA does not place territorial restrictions on
the domestic activities of nonbank subsidiaries of bank holding companies.
Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as
financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including
securities and insurance underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with
9
the Secretary of the Treasury, determines by regulation or order is financial in nature or incidental to any such financial activity or that
the Federal Reserve determines by order to be complementary to any such financial activity and does not pose a substantial risk to the
safety or soundness of FDIC-insured institutions or the financial system generally. The Company has not elected to operate as a
financial holding company.
Federal law also prohibits any person or company from acquiring “control” of an FDIC-insured depository institution or its holding
company without prior notice to the appropriate federal bank regulator. “Control” is conclusively presumed to exist upon the
acquisition of 25% or more of the outstanding voting securities of a bank or bank holding company, but may arise under certain
circumstances between 10% and 24.99% ownership.
Capital Requirements. Bank holding companies are required to maintain capital in accordance with Federal Reserve capital adequacy
requirements, as impacted by the Dodd-Frank Act and Basel III. For a discussion of capital requirements, see “—Regulatory Emphasis
on Capital” above.
Dividend Payments. The Company’s ability to pay dividends to its shareholders may be affected by both general corporate law
considerations and policies of the Federal Reserve applicable to bank holding companies. As a Delaware corporation, the Company is
subject to the limitations of the Delaware General Corporation Law (the “DGCL”). The DGCL allows the Company to pay dividends
only out of its surplus (as defined and computed in accordance with the provisions of the DGCL) or if the Company has no such
surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.
As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company should eliminate, defer or
significantly reduce dividends to shareholders if: (i) its net income available to shareholders for the past four quarters, net of dividends
previously paid during that period, is not sufficient to fully fund the dividends; (ii) the prospective rate of earnings retention is
inconsistent with its capital needs and overall current and prospective financial condition; or (iii) it will not meet, or is in danger of not
meeting, its minimum regulatory capital adequacy ratios. The Federal Reserve also possesses enforcement powers over bank holding
companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of
applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding
companies. In addition, under the Basel III Rule, institutions that seek the freedom to pay dividends will have to maintain 2.5% in
Common Equity Tier 1 attributable to the capital conservation buffer to be phased in over three years beginning in 2016. See “—
Regulatory Emphasis on Capital” above.
Monetary Policy. The monetary policy of the Federal Reserve has a significant effect on the operating results of financial or bank
holding companies and their subsidiaries. Among the tools available to the Federal Reserve to affect the money supply are open market
transactions in U.S. government securities, changes in the discount rate on bank borrowings and changes in reserve requirements
against bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans,
investments and deposits, and their use may affect interest rates charged on loans or paid on deposits.
Federal Securities Regulation. The Company’s common stock is registered with the SEC under the Securities Exchange Act of 1934,
as amended (the “Exchange Act”). Consequently, the Company is subject to the information, proxy solicitation, insider trading and
other restrictions and requirements of the SEC under the Exchange Act.
Corporate Governance. The Dodd-Frank Act addressed many investor protection, corporate governance and executive compensation
matters that will affect most U.S. publicly traded companies. The Dodd-Frank Act increased stockholder influence over boards of
directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute”
payments, and authorizing the SEC to promulgate rules that would allow stockholders to nominate and solicit voters for their own
candidates using a company’s proxy materials. The legislation also directed the Federal Reserve to promulgate rules prohibiting
excessive compensation paid to executives of bank holding companies, regardless of whether such companies are publicly traded.
Regulation and Supervision of the Bank
General. The Bank is a national bank, chartered by the OCC under the National Bank Act. The deposit accounts of the Bank are insured
by the FDIC’s Deposit Insurance Fund (the “DIF”) to the maximum extent provided under federal law and FDIC regulations, and the
Bank is a member of the Federal Reserve System. As a national bank, the Bank is subject to the examination, supervision, reporting and
enforcement requirements of the OCC. The FDIC, as administrator of the DIF, also has regulatory authority over the Bank.
Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the
FDIC. The FDIC has adopted a risk-based assessment system whereby FDIC-insured institutions pay insurance premiums at rates
based on their risk classification. An institution’s risk classification is assigned based on its capital levels and the level of supervisory
concern the institution poses to the regulators. For deposit insurance assessment purposes, an FDIC-insured institution is placed in one
of four risk categories each quarter. An institution’s assessment is determined by multiplying its assessment rate by its assessment base.
In 2015 the total base assessment rates range from 2.5 basis points to 45 basis points. The assessment base is calculated using average
consolidated total assets minus average tangible equity. At least semi-annually, the FDIC will update its loss and income projections for
the DIF and, if needed, will increase or decrease the assessment rates, following notice and comment on proposed rulemaking.
Amendments to the Federal Deposit Insurance Act revised the assessment base against which an FDIC-insured institution’s deposit
insurance premiums paid to the DIF are calculated to be its average consolidated total assets less its average tangible equity. This
change shifted the burden of deposit insurance premiums toward those large depository institutions that rely on funding sources other
than U.S. deposits. Additionally, the Dodd-Frank Act altered the minimum designated reserve ratio of the DIF, increasing the
10
minimum from 1.15% to 1.35% of the estimated amount of total insured deposits and eliminating the requirement that the FDIC pay
dividends to FDIC-insured institutions. In lieu of dividends, the FDIC has adopted progressively lower assessment rate schedules that
will take effect when the reserve ratio exceeds 1.15%, 2%, and 2.5%. As a consequence, premiums will decrease once the 1.15%
threshold is exceeded. The FDIC has until September 3, 2020 to meet the 1.35% reserve ratio target. Several of these provisions could
increase the Bank’s FDIC deposit insurance premiums.
The Dodd-Frank Act also permanently established the maximum amount of deposit insurance for banks, savings institutions and credit
unions to $250,000 per insured depositor.
FICO Assessments. In addition to paying basic deposit insurance assessments, FDIC-insured institutions must pay Financing
Corporation (“FICO”) assessments. FICO is a mixed-ownership governmental corporation chartered by the former Federal Home Loan
Bank Board pursuant to the Competitive Equality Banking Act of 1987 to function as a financing vehicle for the recapitalization of the
former Federal Savings and Loan Insurance Corporation. FICO issued 30-year noncallable bonds of approximately $8.1 billion that
mature in 2017 through 2019. FICO’s authority to issue bonds ended on December 12, 1991. Since 1996, federal legislation has
required that all FDIC-insured institutions pay assessments to cover interest payments on FICO’s outstanding obligations. The FICO
assessment rate is adjusted quarterly and for the fourth quarter of 2015 was 0.60 basis points (60 cents per $100 dollars of assessable
deposits).
Supervisory Assessments. National banks are required to pay supervisory assessments to the OCC to fund the operations of the OCC.
The amount of the assessment is calculated using a formula that takes into account the bank’s size and its supervisory condition. During
the year ended December 31, 2015, the Bank paid supervisory assessments to the OCC totaling $425,000.
Capital Requirements. Banks are generally required to maintain capital levels in excess of other businesses. For a discussion of
capital requirements, see “—Regulatory Emphasis on Capital” above.
Liquidity Requirements. Liquidity is a measure of the ability and ease with which assets may be converted to cash. Liquid assets are
those that can be converted to cash quickly if needed to meet financial obligations. To remain viable, FDIC-insured institutions must
have enough liquid assets to meet their near-term obligations, such as withdrawals by depositors. Because the global financial crisis
was in part a liquidity crisis, Basel III also includes a liquidity framework that requires FDIC-insured institutions to measure their
liquidity against specific liquidity tests. One test, referred to as the Liquidity Coverage Ratio (“LCR”), is designed to ensure that the
institution has an adequate stock of unencumbered high-quality liquid assets that can be converted easily and immediately in private
markets into cash to meet liquidity needs for a 30-calendar day liquidity stress scenario. The other test, known as the Net Stable
Funding Ratio, is designed to promote more medium- and long-term funding of the assets and activities of institutions over a one-year
horizon. These tests provide an incentive for institutions to increase their holdings in Treasury securities and other sovereign debt as a
component of assets, increase the use of long-term debt as a funding source and rely on stable funding like core deposits (in lieu of
brokered deposits).
In addition to liquidity guidelines already in place, the U.S. bank regulatory agencies implemented the Basel III LCR in September
2014, which requires large financial firms to hold levels of liquid assets sufficient to protect against constraints on their funding during
times of financial turmoil. While the LCR only applies to the largest banking organizations in the country, certain elements are
expected to filter down to all FDIC-insured institutions. The Bank is reviewing its liquidity risk management policies in light of the
LCR and NSFR.
Stress Testing. A stress test is an analysis or simulation designed to determine the ability of a given FDIC-insured institution to deal
with an economic crisis. In October 2012, U.S. bank regulators unveiled new rules mandated by the Dodd-Frank Act that require the
largest U.S. banks to undergo stress tests twice per year, once internally and once conducted by the regulators, and began
recommending portfolio stress testing as a sound risk management practice for community banks. Although stress tests are not
officially required for banks with less than $10 billion in assets, they have become part of annual regulatory exams even for banks
small enough to be officially exempted from the process. The OCC now recommends stress testing as means to identify and quantify
loan portfolio risk and the Bank has begun the process.
Dividend Payments. The primary source of funds for the Company is dividends from the Bank. Under the National Bank Act, a
national bank may pay dividends out of its undivided profits in such amounts and at such times as the bank’s board of directors deems
prudent. Without prior OCC approval, however, a national bank may not pay dividends in any calendar year that, in the aggregate, exceed
the bank’s year-to-date net income plus the bank’s retained net income for the two preceding years. In addition, under the Basel III Rule,
institutions that seek the freedom to pay dividends will have to maintain 2.5% in Common Equity Tier 1 attributable to the capital
conservation buffer to be phased in over three years beginning in 2016. See “Regulatory Emphasis on Capital” above.
Insider Transactions. The Bank is subject to certain restrictions imposed by federal law on “covered transactions” between the Bank
and its “affiliates.” The Company is an affiliate of the Bank for purposes of these restrictions, and covered transactions subject to the
restrictions include extensions of credit to the Company, investments in the stock or other securities of the Company and the acceptance
of the stock or other securities of the Company as collateral for loans made by the Bank. The Dodd-Frank Act enhanced the
requirements for certain transactions with affiliates, including an expansion of the definition of “covered transactions” and an increase
in the amount of time for which collateral requirements regarding covered transactions must be maintained.
Limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and
officers of the Company and its subsidiaries, to principal shareholders of the Company and to “related interests” of such directors,
officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person who is a
11
director or officer of the Company or the Bank, or a principal shareholder of the Company, may obtain credit from banks with which
the Bank maintains a correspondent relationship.
Safety and Soundness Standards/Risk Management. The federal banking agencies have adopted guidelines that establish operational
and managerial standards to promote the safety and soundness of FDIC-insured institutions. The guidelines set forth standards for
internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset
growth, compensation, fees and benefits, asset quality and earnings.
In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for
establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the
guidelines, the FDIC-insured institution’s primary federal regulator may require the institution to submit a plan for achieving and
maintaining compliance. If an FDIC-insured institution fails to submit an acceptable compliance plan, or fails in any material respect
to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order
directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the
FDIC-insured institution’s rate of growth, require the FDIC-insured institution to increase its capital, restrict the rates the institution
pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance
with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the
federal bank regulatory agencies, including cease and desist orders and civil money penalty assessments.
During the past decade, the bank regulatory agencies have increasingly emphasized the importance of sound risk management
processes and strong internal controls when evaluating the activities of the FDIC-insured institutions they supervise. Properly
managing risks has been identified as critical to the conduct of safe and sound banking activities and has become even more important
as new technologies, product innovation, and the size and speed of financial transactions have changed the nature of banking
markets. The agencies have identified a spectrum of risks facing a banking institution including, but not limited to, credit, market,
liquidity, operational, legal, and reputational risk. In particular, recent regulatory pronouncements have focused on operational risk,
which arises from the potential that inadequate information systems, operational problems, breaches in internal controls, fraud, or
unforeseen catastrophes will result in unexpected losses. New products and services, third-party risk management and cybersecurity
are critical sources of operational risk that FDIC-insured institutions are expected to address in the current environment. The Bank is
expected to have active board and senior management oversight; adequate policies, procedures, and limits; adequate risk measurement,
monitoring, and management information systems; and comprehensive internal controls.
Branching Authority. National banks headquartered in Illinois, such as the Bank, have the same branching rights in Illinois as banks
chartered under Illinois law, subject to OCC approval. Illinois law grants Illinois-chartered banks the authority to establish branches
anywhere in the State of Illinois, subject to receipt of all required regulatory approvals.
Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state
deposit concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period
of time (not to exceed five years) prior to the merger. The establishment of new interstate branches or the acquisition of individual
branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) has historically been permitted
only in those states the laws of which expressly authorize such expansion. However, the Dodd-Frank Act permits well-capitalized and
well-managed banks to establish new branches across state lines without these impediments.
Financial Subsidiaries. Under federal law and OCC regulations, national banks are authorized to engage, through “financial
subsidiaries,” in any activity that is permissible for a financial holding company and any activity that the Secretary of the Treasury, in
consultation with the Federal Reserve, determines is financial in nature or incidental to any such financial activity, except (i) insurance
underwriting, (ii) real estate development or real estate investment activities (unless otherwise permitted by law), (iii) insurance company
portfolio investments and (iv) merchant banking. The authority of a national bank to invest in a financial subsidiary is subject to a number
of conditions, including, among other things, requirements that the bank must be well-managed and well-capitalized (after deducting from
capital the bank’s outstanding investments in financial subsidiaries). The Bank has not applied for approval to establish any financial
subsidiaries.
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank of Chicago (the “FHLB”), which serves as
a central credit facility for its members. The FHLB is funded primarily from proceeds from the sale of obligations of the FHLB
system. It makes loans to member banks in the form of FHLB advances. All advances from the FHLB are required to be fully
collateralized as determined by the FHLB.
Transaction Account Reserves. Federal Reserve regulations require FDIC-insured institutions to maintain reserves against their
transaction accounts (primarily NOW and regular checking accounts). For 2016: the first $15.2 million of otherwise reservable
balances are exempt from reserves and have a zero percent reserve requirement; for transaction accounts aggregating more than $15.2
million to $110.2 million, the reserve requirement is 3% of total transaction accounts; and for net transaction accounts in excess of
$110.2 million, the reserve requirement is 3% up to $110.2 million plus 10% of the aggregate amount of total transaction accounts in
excess of $110.2 million. These reserve requirements are subject to annual adjustment by the Federal Reserve.
Community Reinvestment Act Requirements. The Community Reinvestment Act requires the Bank to have a continuing and
affirmative obligation in a safe and sound manner to help meet the credit needs of its entire community, including low- and moderate-
income neighborhoods. Federal regulators regularly assess the Bank’s record of meeting the credit needs of its communities.
12
Applications for additional acquisitions would be affected by the evaluation of the Bank’s effectiveness in meeting its Community
Reinvestment Act requirements.
Anti-Money Laundering. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct
Terrorism Act of 2001 (the “USA Patriot Act”), along with anti-money laundering and bank secrecy laws (“AML-BSA”), are designed
to deny terrorists and criminals the ability to obtain access to the U.S. financial system and has significant implications for FDIC-
insured institutions, brokers, dealers and other businesses involved in the transfer of money. The laws mandate financial services
companies to have policies and procedures with respect to measures designed to address any or all of the following matters: (i)
customer identification and ongoing due diligence programs; (ii) money laundering; (iii) terrorist financing; (iv) identifying and
reporting suspicious activities and currency transactions; (v) currency crimes; and (vi) cooperation among FDIC-insured institutions
and law enforcement authorities.
Concentrations in Commercial Real Estate. Concentration risk exists when FDIC-insured institutions deploy too many assets to any
one industry or segment. A concentration in commercial real estate is one example of regulatory concern. The interagency
Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices guidance (“CRE Guidance”) provides
supervisory criteria, including the following numerical indicators, to assist bank examiners in identifying banks with potentially
significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny: (i) commercial real estate loans
exceeding 300% of capital and increasing 50% or more in the preceding three years; or (ii) construction and land development loans
exceeding 100% of capital. The CRE Guidance does not limit banks’ levels of commercial real estate lending activities, but rather
guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of
their commercial real estate concentrations. On December 18, 2015, the federal banking agencies issued a statement to reinforce
prudent risk-management practices related to CRE lending, having observed substantial growth in many CRE asset and lending
markets, increased competitive pressures, rising CRE concentrations in banks, and an easing of CRE underwriting standards. The
federal bank agencies reminded FDIC-insured institutions to maintain underwriting discipline and exercise prudent risk-management
practices to identify, measure, monitor, and manage the risks arising from CRE lending. In addition, FDIC-insured institutions must
maintain capital commensurate with the level and nature of their CRE concentration risk based on the Bank’s loan portfolio as of
December 31, 2015.
Consumer Financial Services. The historical structure of federal consumer protection regulation applicable to all providers of
consumer financial products and services changed significantly on July 21, 2011, when the CFPB commenced operations to supervise
and enforce consumer protection laws. The CFPB has broad rulemaking authority for a wide range of consumer protection laws that
apply to all providers of consumer products and services, including the Bank, as well as the authority to prohibit “unfair, deceptive or
abusive” acts and practices. The CFPB has examination and enforcement authority over providers with more than $10 billion in assets.
FDIC-insured institutions with $10 billion or less in assets, like the Bank, continue to be examined by their applicable bank regulators.
Because abuses in connection with residential mortgages were a significant factor contributing to the global financial crisis, many new
rules issued by the CFPB and required by the Dodd-Frank Act address mortgage and mortgage-related products, their underwriting,
origination, servicing and sales. The Dodd-Frank Act significantly expanded underwriting requirements applicable to loans secured by
1-4 family residential real property and augmented federal law combating predatory lending practices. In addition to numerous
disclosure requirements, the Dodd-Frank Act imposed new standards for mortgage loan originations on all lenders, including all FDIC-
insured institutions, in an effort to strongly encourage lenders to verify a borrower’s “ability to repay,” while also establishing a
presumption of compliance for certain “qualified mortgages.” In addition, the Dodd-Frank Act generally required lenders or
securitizers to retain an economic interest in the credit risk relating to loans that the lender sells, and other asset-backed securities that
the securitizer issues, if the loans have not complied with the ability-to-repay standards. The Bank does not currently expect the
CFPB’s rules to have a significant impact on the Company’s operations, except for higher compliance costs.
GUIDE 3 STATISTICAL DATA REQUIREMENTS
The statistical data required by Guide 3 of the Guides for Preparation and Filing of Reports and Registration Statements under the
Securities Exchange Act of 1934 is set forth in the following pages. This data should be read in conjunction with the consolidated
financial statements, related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" as
set forth in Part II Items 7 and 8. All dollars in the tables are expressed in thousands.
13
I.
Distribution of Assets, Liabilities and Stockholders’ Equity; Interest Rate and Interest Differential.
The following table sets forth certain information relating to the Company’s average consolidated balance sheets and reflects the yield
on average earning assets and cost of average liabilities for the years indicated. Dividing the related interest by the average balance of
assets or liabilities derives rates. Average balances are derived from daily balances.
ANALYSIS OF AVERAGE BALANCES,
TAX EQUIVALENT INTEREST AND RATES
Years ended December 31, 2015, 2014 and 2013
Assets
Interest bearing deposits with financial institutions $
Securities:
Taxable
Non-taxable (TE)
Total securities
Dividends from Reserve Bank and FHLBC stock
Loans and loans held-for-sale1
Total interest earning assets
Cash and due from banks
Allowance for loan losses
Other noninterest bearing assets
Total assets
Liabilities and Stockholders' Equity
NOW accounts
Money market accounts
Savings accounts
Time deposits
Interest bearing deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Subordinated debt
Notes payable and other borrowings
Total interest bearing liabilities
Noninterest bearing deposits
Other liabilities
Stockholders' equity
Total liabilities and stockholders' equity
Net interest income (TE)
Net interest income (TE)
to total earning assets
2015
2014
2013
Average
Balance
Interest %
Rate Average
Balance
Interest %
Rate Average
Balance
Rate
Interest %
20,066
$
55 0.27 $
28,106
$
73 0.26 $
43,801
$
108 0.24
642,132
22,311
664,443
8,545
1,149,590
1,842,644
29,659
(19,323)
213,000
$ 2,065,980
14,037 2.19
834 3.74
14,871 2.24
306 3.58
616,187
16,425
632,612
9,677
53,327 4.58 1,127,590
1,797,985
68,559 3.68
32,628
-
-
(24,981)
-
-
231,767
-
-
$ 2,037,399
14,131 2.29
727 4.43
14,858 2.35
309 3.19
586,188
14,616
600,804
10,629
53,170 4.65 1,106,447
1,761,681
68,410 3.76
26,871
-
-
(35,504)
-
-
209,640
-
-
$ 1,962,688
11,692 1.99
904 6.19
12,596 2.10
304 2.86
56,417 5.03
69,425 3.90
-
-
-
-
-
-
$ 345,472
292,725
249,570
410,691
1,298,458
28,194
21,945
58,378
45,000
500
1,452,475
429,403
10,712
173,390
$ 2,065,980
$
300 0.09 $
282 0.10
152 0.06
3,201 0.78
3,935 0.30
3 0.01
30 0.13
4,287 7.34
814 1.78
7 1.38
9,076 0.62
-
-
-
-
-
-
314,212
305,595
238,326
446,133
1,304,266
26,093
12,534
58,378
45,000
500
1,446,771
388,295
20,218
182,115
$ 2,037,399
$
266 0.08 $ 290,998
318,343
317 0.10
226,404
155 0.07
493,855
4,500 1.01
1,329,600
5,238 0.40
23,313
3 0.01
15,849
16 0.13
58,378
4,919 8.43
45,000
792 1.74
500
16 3.16
1,472,640
10,984 0.76
362,871
-
-
36,063
-
-
91,114
-
-
$ 1,962,688
$
255 0.09
443 0.14
161 0.07
6,774 1.37
7,633 0.57
3 0.01
25 0.16
5,298 9.08
811 1.78
16 3.16
13,786 0.94
-
-
-
-
-
-
$ 59,483
$ 57,426
$ 55,639
3.23
3.19
3.16
Interest bearing liabilities to earning assets
78.83 %
80.47 %
83.59 %
1. Interest income from loans is shown tax equivalent as discussed below and includes fees of $1.8 million, $2.3 million and $2.5 million for 2015, 2014 and 2013, respectively. Nonaccrual
loans are included in the above stated average balances.
Notes: For purposes of discussion, net interest income and net interest income to earning assets have been adjusted to a non-GAAP tax equivalent (“TE”) basis using a
marginal rate of 35% to more appropriately compare returns on tax-exempt loans and securities to other earning assets. The table below provides a reconciliation of each
non-GAAP TE measure to the GAAP equivalent:
Interest income (GAAP)
Taxable equivalent adjustment - loans
Taxable equivalent adjustment - securities
Interest income (TE)
Less: interest expense (GAAP)
Net interest income (TE)
Net interest income (GAAP)
Average interest earning assets
Net interest income to total interest earning assets
Net interest income to total interest earning assets (TE)
Effect of Tax Equivalent Adjustment
2014
$
$
$
68,044
111
255
68,410
10,984
57,426
57,060
1,797,985
3.17 %
3.19 %
$
$
$
2013
69,040
68
317
69,425
13,786
55,639
55,254
1,761,681
3.14 %
3.16 %
$
$
$
2015
68,164
103
292
68,559
9,076
59,483
59,088
1,842,644
3.21 %
3.23 %
14
The following table allocates the changes in net interest income to changes in either average balances or average rates for earnings
assets and interest bearing liabilities. Interest income is measured on a tax-equivalent basis using a 35% rate as per the note to the
analysis of average balance table on the preceding page.
Analysis of Year-to-Year Changes in Net Interest Income
2015 Compared to 2014
Change Due to
Average
Balance
Average
Rate
2014 Compared to 2013
Change Due to
Total
Change
Average
Balance
Average
Rate
Total
Change
EARNING ASSETS/INTEREST INCOME
Interest bearing deposits
Securities:
Taxable
Tax-exempt
Dividends from Reserve Bank and FHLBC stock
Loans and loans held-for-sale
TOTAL EARNING ASSETS
INTEREST BEARING LIABILITIES/ INTEREST EXPENSE
NOW accounts
Money market accounts
Savings accounts
Time deposits
Other short-term borrowings
Junior subordinated debentures
Subordinated debt
Notes payable and other borrowings
INTEREST BEARING LIABILITIES
NET INTEREST INCOME
II.
Investment Portfolio
$
(22)
$
4
$
(18) $
(41)
$
6
$
(35)
845
189
78
937
2,027
27
(13)
9
(336)
13
-
-
-
(300)
2,327
$
(939)
(82)
(81)
(780)
(1,878)
7
(22)
(12)
(963)
1
(632)
22
(9)
(1,608)
(270)
$
(94)
107
(3)
157
149
34
(35)
(3)
(1,299)
14
(632)
22
(9)
(1,908)
2,057 $
621
136
(17)
1,106
1,805
19
(17)
10
(608)
(5)
-
-
-
(601)
2,406
$
1,818
(313)
22
(4,353)
(2,820)
(8)
(109)
(16)
(1,666)
(4)
(379)
(19)
-
(2,201)
(619)
$
2,439
(177)
5
(3,247)
(1,015)
11
(126)
(6)
(2,274)
(9)
(379)
(19)
-
(2,802)
1,787
$
The following table presents the composition of the securities portfolio by major category as of December 31 of each year indicated:
Securities Portfolio Composition
2015
2014
2013
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
Securities Available-For-Sale
U.S. Treasury
U.S. government agencies
U.S. government agency mortgage-backed
States and political subdivisions
Corporate bonds
Collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Total Securities Available-For-Sale
Held-To-Maturity
U.S. government agency mortgage-backed
Collateralized mortgage obligations
Total Held-To-Maturity
$
1,509
1,683
2,040
30,341
30,157
68,743
241,872
94,374
$ 470,719
$
1,509 $
1,556
1,996
30,526
29,400
66,920
231,908
92,251
1,529
1,711
-
21,682
31,243
65,728
175,565
94,236
$ 456,066 $ 391,694
$
1,527
1,624
-
22,018
30,985
63,627
173,496
92,209
$ 385,486
$
1,549
1,738
-
16,382
15,733
66,766
274,118
-
$ 376,286
$
1,544
1,672
-
16,794
15,102
63,876
273,203
-
$ 372,191
$
36,505
211,241
$ 247,746
38,097 $
37,125
$
213,578
222,545
$ 251,675 $ 259,670
39,155
$
224,111
$ 263,266
35,268
$
221,303
$ 256,571
35,240
$
219,088
$ 254,328
The Company’s holdings of U.S. government agency and U.S. government agency mortgage-backed securities are comprised of
government-sponsored enterprises, such as Fannie Mae, Freddie Mac and the FHLB, which are not backed by the full faith and credit
of the U.S. government.
15
The following table presents the expected maturities or call dates and weighted average yield (nontax equivalent) of securities by major
category as of December 31, 2015. Securities not due at a single maturity date are shown only in the total column.
Securities Portfolio Maturity and Yields
Securities Available-For-Sale
U.S. Treasury
U.S. government agencies
States and political subdivisions
Corporate bonds
Mortgage-backed securities and collateralized
mortgage obligations
Asset-backed securities
Collateralized loan obligations
After One But
Within One Year Within Five Years Within Ten Years
Amount Yield Amount Yield Amount Yield Amount Yield Amount
After Ten Years
After Five But
Total
Yield
$
1,509
-
15,629
-
17,138
0.40 % $
-
1.87
-
1.74
-
-
4,932
2,027
6,959
- % $
-
3.28
2.06
2.92
-
1,556
5,242
27,373
34,171
- % $
3.13
3.09
2.22
2.39
-
-
4,723
-
4,723
- % $
-
3.21
-
3.21
1,509
1,556
30,526
29,400
62,991
0.40 %
3.13
2.51
2.21
2.33
68,916
231,908
92,251
456,066
2.29
1.47
3.06
2.03 %
Total Securities Available-For-Sale
$ 17,138
1.74 % $
6,959
2.92 % $
34,171
2.39 % $
4,723
3.21 % $
Held-To-Maturity
Mortgage-backed securities and collateralized
mortgage obligations
Total Held-To-Maturity
$
-
- % $
-
- % $
-
- % $
-
$
- % $
247,746
247,746
2.78 %
2.78 %
As of December 31, 2015, net unrealized losses on available-for-sale securities and net losses not accreted on securities transferred
from available-for-sale to held-to-maturity was $20.6 million, which offset by deferred income taxes resulted in an overall reduction to
equity capital of $12.3 million. As of December 31, 2014, net unrealized losses on available-for-sale securities and net losses not
accreted on securities transferred from available-for-sale to held-to-maturity was $13.1 million, which offset by deferred income taxes
resulted in an overall reduction to equity capital of $7.7 million.
At December 31, 2015, there were three issuers of securities where the book value of the Company’s holdings were greater than 10% of
stockholders’ equity. Issuers of Securities with an aggregate book value greater than 10% of stockholders equity at
December 31, 2015, were as follows;
Issuer
College Loan Corporation
Nelnet Student Loan
GCO Education Loan Funding Corp
III.
Loan Portfolio
December 31, 2015
Fair
Value
Amortized
Cost
73,293
23,359
37,508
$
$
70,254
23,291
35,263
The following table presents the composition of the loan portfolio at December 31 for the years indicated:
Types of Loans
Commercial
Real estate - commercial
Real estate - construction
Real estate - residential
Consumer
Overdraft
Lease Financing Receivables
Other
Gross loans
Allowance for loan losses
Loans, net
$
2015
131,102 $
605,721
19,806
350,557
4,963
483
10,953
10,130
1,133,715
(16,223)
2014
119,717
600,629
44,795
369,870
4,004
649
8,038
11,630
1,159,332
(21,637)
$ 1,117,492 $ 1,137,695
$
2013
95,211
560,233
29,351
389,931
3,040
628
10,069
12,793
1,101,256
(27,281)
$ 1,073,975
$
2012
87,136
579,687
42,167
414,141
3,414
994
6,060
16,451
1,150,050
(38,597)
$ 1,111,453
$
2011
98,241
704,415
70,919
477,196
4,172
457
2,087
11,498
1,368,985
(51,997)
$ 1,316,988
The above loan totals include deferred loan fees and costs.
16
Maturity and Rate Sensitivity of Loans to Changes in Interest Rates
The following table sets forth the remaining contractual maturities for certain loan categories at December 31, 2015:
Commercial
Real estate - commercial
Real estate - construction
Real estate - residential
Consumer
Overdraft
Lease financing receivables
Other
Total
One Year
or Less
$
45,692
33,246
6,056
22,933
714
483
73
2,576
$ 111,773
Over 1 Year
Through 5 Years
Fixed
Rate
39,676
$
392,302
9,107
66,450
3,374
-
7,208
416
$ 518,533
Floating
$
Rate
30,387
42,731
637
52,591
764
-
-
6,249
$ 133,359
Over 5 Years
$
Fixed
Rate
12,793
73,219
1,754
34,489
111
-
3,672
189
$ 126,227
Floating
Rate
$
2,554
64,223
2,252
174,094
-
-
-
700
$ 243,823
Total
131,102
605,721
19,806
350,557
4,963
483
10,953
10,130
1,133,715
$
$
The above loan total includes deferred loan fees and costs; column one includes demand notes.
While there are no significant concentrations of loans where the customers’ ability to honor loan terms is dependent upon a single
economic sector, the real estate related categories represented 86.1% and 87.6% of the portfolio at December 31, 2015 and 2014,
respectively. The Company had no concentration of loans exceeding 10% of total loans that were not otherwise disclosed as a category
of loans at December 31, 2015.
Risk Elements
The following table sets forth the amounts of nonperforming assets at December 31 of the years indicated:
Nonaccrual loans
Nonperforming Troubled debt restructured loans accruing interest
Loans past due 90 days or more and still accruing interest
Total nonperforming loans
Other real estate owned
Total nonperforming assets
2015
2014
2013
$
$
14,389
165
65
14,619
19,141
33,760
$
$
26,926
154
-
27,080
31,982
59,062
$
$
38,911
796
87
39,794
41,537
81,331
$
$
2012
77,519
4,987
89
82,595
72,423
155,018
$
$
2011
126,786
11,839
318
138,943
93,290
232,233
Other real estate owned ("OREO") as % of nonperforming assets
56.7 %
54.1 %
51.1 %
46.7 %
40.2 %
Accrual of interest is discontinued on a loan when principal or interest is ninety days or more past due, unless the loan is well secured
and in the process of collection. When a loan is placed on nonaccrual status, interest previously accrued but not collected in the current
period is reversed against current period interest income. Interest income of approximately $116,000, $511,000 and $333,000 was
recorded and collected during 2015, 2014 and 2013, respectively, on loans that subsequently went to nonaccrual status by year-end.
Interest income, which would have been recognized during 2015, 2014 and 2013, had these loans been on an accrual basis throughout
the year, was approximately $815,000, $1.8 million and $3.0 million respectively. There were approximately $4.4 million and $4.8
million in restructured residential mortgage loans that were still accruing interest based upon their prior performance history at
December 31, 2015 and 2014, respectively. Additionally, the nonaccrual loans above include $2.9 million and $5.1 million in
restructured loans for the period ending December 31, 2015 and 2014, respectively.
Potential Problem Loans
The Company utilizes an internal asset classification system as a means of reporting problem and potential problem assets. At the
scheduled board of directors meetings of the Bank, loan listings are presented, which show significant loan relationships listed as
“Special Mention,” “Substandard,” and “Doubtful.” Loans classified as Substandard include those that have a well-defined weakness
or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will
sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all the weaknesses inherent as those classified
Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing
facts, conditions and values, highly questionable and improbable. Assets that do not currently expose us to sufficient risk to warrant
classification in one of the aforementioned categories, but possess weaknesses that deserve management’s close attention, are deemed
to be Special Mention.
Management defines potential problem loans as performing loans rated Substandard that do not meet the definition of a nonperforming
loan. These potential problem loans carry a higher probability of default and require additional attention by management. A more
detailed description of these loans can be found in Note 4 to the Financial Statements.
17
IV.
Summary of Loan Loss Experience
Analysis of Allowance for Loan Losses
The following table summarizes, for the years indicated, activity in the allowance for loan losses, including amounts charged-off,
amounts of recoveries, additions to the allowance charged to operating expense, and the ratio of net charge-offs to average loans
outstanding:
Average total loans (exclusive of loans held-for-sale)
Allowance at beginning of year
Charge-offs:
Commercial
Real estate - commercial
Real estate - construction
Real estate - residential
Consumer and other loans
Total charge-offs
Recoveries:
Commercial
Real estate - commercial
Real estate - construction
Real estate - residential
Consumer and other loans
Total recoveries
Net charge-offs
Provision for loan losses
Allowance at end of year
2015
2014
2013
2012
2011
$
1,144,618
21,637
$
1,124,335
27,281
$
1,102,197
38,597
$
1,263,172
51,997
$
1,527,311
76,308
993
1,653
2
1,639
483
4,770
451
1,595
276
1,075
359
3,756
1,014
(4,400)
16,223
$
578
1,972
174
3,393
526
6,643
58
1,346
633
1,842
420
4,299
2,344
(3,300)
21,637
$
316
2,985
1,014
6,293
597
11,205
119
5,325
1,266
1,221
508
8,439
2,766
(8,550)
27,281
$
344
13,508
4,969
8,406
638
27,865
115
3,576
3,420
583
487
8,181
19,684
6,284
38,597
$
366
19,576
10,430
10,229
568
41,169
173
3,947
1,262
1,807
782
7,971
33,198
8,887
51,997
$
Net charge-offs to average loans
Allowance at year-end to average loans
0.09 %
1.42 %
0.21 %
1.92 %
0.25 %
2.48 %
1.56 %
3.06 %
2.17 %
3.40 %
The provision for loan losses is based upon management’s estimate of losses inherent in the portfolio and its evaluation of the adequacy
of the allowance for loan losses. Factors which influence management’s judgment in estimating loan losses are the composition of the
portfolio, past loss experience, loan delinquencies, nonperforming loans and other credit risk considerations that, in management’s
judgment, deserve evaluation in estimating loan losses. The Company has consistently followed GAAP and regulatory guidance in all
calculation methodologies with no significant criticism of those methodologies from outside third party evaluations.
Allocation of the Allowance for Loan Losses
The following table shows the Company’s allocation of the allowance for loan losses by types of loans and the amount of unallocated
allowance at December 31 of the years indicated:
2015
Loan Type
to Total
2014
Loan Type
to Total
2013
Loan Type
to Total
2012
Loan Type
to Total
2011
Loan Type
to Total
Amount Loans
Amount Loans
Amount Loans
Amount Loans
Amount Loans
Commercial
Real estate - commercial
Real estate - construction
Real estate - residential
Consumer
Unallocated
Total
$
2,096
9,013
265
1,694
1,190
1,965
$ 16,223
12.5 % $ 1,644
53.4 % 12,577
1,475
1.7 %
1,981
31.0 %
1,454
0.4 %
2,506
1.0 %
100.0 % $ 21,637
11.0 % $ 2,250
51.8 % 16,763
1,980
3.9 %
2,837
31.9 %
1,439
0.3 %
2,012
1.1 %
100.0 % $ 27,281
9.5 % $ 4,517
50.9 % 20,100
3,837
2.7 %
4,535
35.4 %
1,178
0.3 %
4,430
1.2 %
100.0 % $ 38,597
7.7 % $ 5,070
50.4 % 30,770
7,937
3.7 %
6,335
36.0 %
884
0.3 %
1,001
1.9 %
100.0 % $ 51,997
7.3 %
51.5 %
5.2 %
34.9 %
0.3 %
0.8 %
100.0 %
The allowance for loan losses is a valuation allowance for loan losses, increased by the provision for loan losses and decreased by both
loan loss reserve releases ($4.4 million loan loss reserve release in 2015, $3.3 million loan loss reserve release in 2014 and $8.6 million
loan loss reserve release in 2013) and charge-offs less recoveries. Allocations of the allowance may be made for specific loans, but the
entire allowance is available for losses inherent in the loan portfolio. In addition, the OCC, as part of their examination process,
periodically reviews the allowance for loan losses. Regulators can require management to record adjustments to the allowance level
based upon their assessment of the information available to them at the time of examination. The OCC, in conjunction with the other
federal banking agencies, has adopted an interagency policy statement on the allowance for loan losses. The policy statement provides
guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate
allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Generally,
the policy statement recommends that (1) institutions have effective systems and controls to identify, monitor and address asset quality
problems; (2) management has analyzed all significant factors that affect the collectability of the portfolio in a reasonable manner; and
(3) management has established acceptable allowance evaluation processes that meet the objectives set forth in the policy statement and
that the Company is in full compliance with the policy statement. Management believes it has established an adequate estimated
18
allowance for probable loan losses. Management reviews its process quarterly as evidenced by an extensive and detailed loan review
process, makes changes as needed, and reports those results at meetings of the Company’s Board of Directors Audit Committee.
Although management believes the allowance for loan losses is sufficient to cover probable losses inherent in the loan portfolio, there
can be no assurance that the allowance will prove sufficient to cover actual loan losses or that regulators, in reviewing the loan
portfolio, would not request us to materially adjust our allowance for loan losses at the time of their examination.
V.
Deposits
The following table sets forth the amount and maturities of deposits of $100,000 or more at December 31 of the years indicated:
3 months or less
Over 3 months through 6 months
Over 6 months through 12 months
Over 12 months
2015
30,085
10,464
29,295
102,669
172,513
$
$
2014
30,580
19,353
38,877
79,587
168,397
$
$
YTD Average Balances and Interest Rates
2015
2014
2013
Average
Balance
Rate
Average
Balance
Rate
Average
Balance
Rate
Noninterest bearing demand
Interest bearing:
NOW and money market
Savings
Time
Total deposits
$
429,403
- % $
388,295
- % $
362,871
- %
638,197
249,570
410,691
1,727,861
0.09
0.06
0.78
619,807
238,326
446,133
1,692,561
$
$
0.09
0.07
1.01
609,341
226,404
493,855
0.11
0.07
1.37
$
1,692,471
VI.
Return on Equity and Assets
The following table presents selected financial ratios as of December 31 for the years indicated:
Return on average total assets
Return on average equity
Average equity to average assets
Dividend payout ratio
VII.
Short-Term Borrowings
2015 2014 2013
0.50 %
4.18 %
5.57 % 90.09 %
4.64 %
8.94 %
-
-
0.74 %
8.87 %
8.39 %
-
There were no categories of short-term borrowings having an average balance greater than 30% of the Company’s stockholders’ equity
as of December 31, 2015, 2014 and 2013.
Item 1.A. Risk Factors
RISK FACTORS
The material risks that management believes affect the Company are described below. Before making an investment decision with
respect to any of the Company’s securities, you should carefully consider the risks as described below, together with all of the
information included herein. The risks described below are not the only risks the Company faces. Additional risks not presently known
also may have a material adverse effect on the Company’s results of operations and financial condition. The risks discussed below also
include forward-looking statements, and actual results may differ substantially from those discussed or implied in these forward-
looking statements.
Risks Relating to the Company’s Business
A return of recessionary conditions could result in increases in the Company’s level of nonperforming loans and/or reduced
demand for the Company’s products and services, which could lead to lower revenue, higher loan losses and lower earnings.
A return of recessionary conditions and/or negative developments in the domestic and international credit markets may significantly
affect the markets in which the Company does business, the value of its loans and investments and its ongoing operations, costs and
19
profitability. Declines in real estate values and sales volumes and increased unemployment or underemployment levels may result in
higher than expected loan delinquencies, increases in the Company’s levels of nonperforming and classified assets and a decline in
demand for its products and services. These negative events may cause the Company to incur losses and may adversely affect its
capital, liquidity and financial condition.
The size of the Company’s loan portfolio has not grown in recent years, and, if the Company is unable to return to loan growth,
its profitability may be adversely affected.
Since December 31, 2010, the Company’s gross loans held for investment have declined from $1.69 billion to $1.13 billion at
December 31, 2015. During some years in this period, the Company was managing its balance sheet composition to manage its capital
levels and position the Bank to meet and exceed its targeted capital levels. The Company’s ability to increase profitability will depend
on a variety of factors, including its ability to originate attractive new lending relationships. While the Company believes it has the
management resources and lending staff in place to continue the successful implementation of its strategic plan, if the Company is
unable to increase the size of its loan portfolio, its strategic plan may not be successful and its profitability may be adversely affected.
The Company has incurred net losses in the past and cannot ensure that the Company will not incur further net losses in the
future.
Although the Company reported net income of $15.4 million in 2015, $10.1 million in 2014 and $82.1 million in 2013, the Company
has incurred losses in the past, including a net loss of $72,000 in 2012 and $6.5 million in 2011. Despite a general improvement in the
overall economy and the real estate market, the economic environment remains challenging, particularly in our market area, and the
Company cannot ensure it will not incur future losses. Any future losses may affect its ability to meet its expenses or raise additional
capital and may delay the time in which the Company can resume dividend payments on its common stock. In addition, future losses
may cause the Company to re-establish a valuation allowance against its deferred tax assets. Furthermore, any future losses would
likely cause a decline in its holding company regulatory capital ratios, which could materially and adversely affect its financial
condition, liquidity and results of operations.
Nonperforming assets take significant time to resolve, adversely affect the Company’s results of operations and financial
condition and could result in further losses in the future.
At December 31, 2015, the Company’s nonperforming loans (which consist of nonaccrual loans and loans past due 90 days or more,
still accruing interest and restructured loans still accruing interest) and its nonperforming assets (which include nonperforming loans
plus OREO) are reflected in the table below (in millions):
Nonperforming loans
OREO
Nonperforming assets
12/31/2015 12/31/2014 % Change
$
14.6 $
19.1
33.8 $
27.1
32.0
59.1
(46.0)
(40.2)
(42.8)
$
The Company’s nonperforming assets adversely affect its net income in various ways. For example, the Company does not accrue
interest income on nonaccrual loans and OREO may have expenses in excess of lease revenues collected, thereby adversely affecting
the Company’s net income, return on assets and return on equity. The Company’s loan administration costs also increase because of its
nonperforming assets. The resolution of nonperforming assets requires significant time commitments from management, which can be
detrimental to the performance of their other responsibilities. While the Company has made significant progress in reducing its
nonperforming assets, there is no assurance that it will not experience increases in nonperforming assets in the future, or that its
nonperforming assets will not result in further losses in the future.
The Company’s loan portfolio is concentrated heavily in commercial and residential real estate loans, including exposure to
construction loans, which involve risks specific to real estate values and the real estate markets in general, all of which have
experienced significant weakness.
The Company’s loan portfolio generally reflects the profile of the communities in which the Company operates. Because the Company
operates in areas that saw rapid historical growth, real estate lending of all types is a significant portion of its loan portfolio. Total real
estate lending, excluding deferred fees, remains at $976.5 million, or approximately 86.1% of the Company’s December 31, 2015 loan
portfolio compared to $1.02 billion or approximately 87.6% at December 31, 2014. Given that the primary (if not only) source of
collateral on these loans is real estate, additional adverse developments affecting real estate values in the Company’s market area could
increase the credit risk associated with the Company’s real estate loan portfolio.
The effects of ongoing real estate challenges, combined with the ongoing correction in commercial and residential real estate market
prices and reduced levels of home sales, have adversely affected the Company’s real estate loan portfolio and have the potential to
20
further adversely affect such portfolio in several ways, each of which could further adversely impact its financial condition and results
of operations.
Real estate market volatility and future changes in disposition strategies could result in net proceeds that differ significantly
from fair value appraisals of loan collateral and OREO and could negatively impact the Company’s operating performance.
Many of the Company’s nonperforming real estate loans are collateral-dependent, meaning the repayment of the loan is largely
dependent upon the successful operation of the property securing the loan. For collateral-dependent loans, the Company estimates the
value of the loan based on appraised value of the underlying collateral less costs to sell. The Company’s OREO portfolio essentially
consists of properties acquired through foreclosure or deed in lieu of foreclosure in partial or total satisfaction of certain loans as a
result of borrower defaults. Some property in OREO reflects property formerly utilized as a bank premise or land that was acquired
with the expectation that a bank premise would be established at the location.
OREO is recorded at the lower of the recorded investment in the loans for which property served as collateral or estimated fair value,
less estimated selling costs. In determining the value of OREO properties and loan collateral, an orderly disposition of the property is
generally assumed. Significant judgment is required in estimating the fair value of property, and the period of time within which such
estimates can be considered current is significantly shortened during periods of market volatility.
The Company’s allowance for loan losses may be insufficient to absorb potential losses in the Company’s loan portfolio.
The Company maintains an allowance for loan losses at a level the Company believes adequate to absorb estimated losses inherent in
its existing loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific
credit risks; credit loss experience; current loan portfolio quality; present economic, political, and regulatory conditions; and
unidentified losses inherent in the current loan portfolio.
Determination of the allowance is inherently subjective since it requires significant estimates and management judgment of credit risks
and future trends, all of which may undergo material changes. For example, the final allowance for December 31, 2015, December 31,
2014, and December 31, 2013, included an amount reserved for other not specifically identified risk factors. New information
regarding existing loans, identification of additional problem loans, and other factors, both within and outside of the Company’s
control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review the
Company’s allowance and may require an increase in the provision for loan losses or the recognition of additional loan charge-offs,
based on judgments different from those of management. Finally, if charge-offs in future periods exceed the allowance for loan losses,
the Company will need additional provisions to increase the allowance. Any increases in the allowance will result in a decrease in net
income and capital and may have a material adverse effect on the Company’s financial condition and results of operations.
While the Company had loan loss reserve releases in 2013, 2014 and 2015, its provision for loan losses was elevated in several
prior years and the Bank may be required to make increases in the provision for loan losses and to charge-off additional loans
in the future.
For the years ended December 31, 2015, 2014 and 2013, the Company recorded a loan loss reserve release of $4.4 million, $3.3 million
and $8.6 million, respectively. While levels of net loan charge – offs, nonperforming assets and classified assets have all improved
over that period, events in the Company’s markets or in the national economy could impact those key metrics. If the economy and/or
the real estate market do not continue to improve, more of the Company’s classified assets may become nonperforming and the
Company may be required to take additional provisions to increase its allowance for loan losses for these assets as the value of the
collateral may be insufficient to pay any remaining net loan balance, which could have a negative effect on the Company’s results of
operations. The Company maintains an allowance for loan losses to provide for loans in its portfolio that may not be repaid in their
entirety. The Company believes that its allowance for loan losses is maintained at a level adequate to absorb probable losses inherent
in its loan portfolio as of the corresponding balance sheet date. However, the Company’s allowance for loan losses may not be
sufficient to cover actual loan losses and future provisions for loan losses could materially adversely affect its operating results.
The Company’s business is concentrated in and dependent upon the welfare of several counties in Illinois specifically and the
State of Illinois generally.
The Company’s primary market area is Aurora, Illinois, and surrounding communities as well as Cook County. The city of Aurora is
located in northeastern Illinois, approximately 40 miles west of Chicago. The Bank operates primarily in Kane, Kendall, DeKalb,
DuPage, LaSalle, Will and Cook counties in Illinois, and, as a result, the Company’s financial condition, results of operations and cash
flows are subject to changes and fluctuations in the economic conditions in those areas.
The communities that the Company serves grew rapidly during the early 21st century, and despite the economic downturn that hit the
Company’s markets, the Company intends to continue concentrating its business efforts in these communities. The Company’s future
success is largely dependent upon the overall economic health of these communities and the ability of the communities to continue to
rebound from the difficulties that began in 2007. While the economies in our market have stabilized, difficult economic conditions
remain, and the State of Illinois’ continues to experience severe budget shortfalls with elected representatives unable to reach an
21
agreement on a state budget. Payment lapses by the State of Illinois to its vendors and government sponsored entities may have
negative effects on our primary market area. To the extent that these issues, or any future state tax increases, impact the economic
vitality of the businesses operating in Illinois, encourage businesses to leave the state or discourage new employers to start or move
businesses to Illinois, they could have a material adverse effect on the Company’s financial condition and results of operations.
If the overall economic conditions do not continue to improve or decline further, particularly within the Company’s primary market
areas, the Company could experience a lack of demand for its products and services, an increase in loan delinquencies and defaults and
high or increased levels of problem assets and foreclosures with little prospect of state governmental issue resolution or assistance, even
contractual assistance. Moreover, because of the Company’s geographic concentration, it is less able than other regional or national
financial institutions to diversify its credit risks across multiple markets.
Credit downgrades, partial charge-offs and specific reserves could develop in selected exposures with resulting impact on the
Company’s financial condition if the State of Illinois encounters more severe financial difficulties. Management continues to closely
monitor the impact of developments on our markets and customers.
The Company operates in a highly competitive industry and market area and may face severe competitive disadvantages.
The Company faces substantial competition in all areas of its operations from a variety of different competitors, many of which are
larger and have more financial resources. The Company’s competitors primarily include national and regional banks as well as
community banks within the markets the Company serves. Recently, local competitors have expanded their presence in the western
suburbs of Chicago, including the communities that surround Aurora, Illinois, and these competitors may be better positioned than the
Company to compete for loans, acquisitions and personnel. The Company also faces competition from savings and loan associations,
credit unions, personal loan and finance companies, retail and discount stockbrokers, investment advisors, mutual funds, insurance
companies, and other financial intermediaries. The financial services industry could become even more competitive as a result of
legislative and regulatory changes. Banks, securities firms, and insurance companies can merge under the umbrella of a financial
holding company, which can offer a wide spectrum of financial services to many customer segments. Many large scale competitors can
leverage economies of scale and be able to offer better pricing for products and services compared to what the Company can offer.
The Company’s ability to compete successfully depends on developing and maintaining long-term customer relationships, offering
community banking services with features and pricing in line with customer interests and expectations, consistently achieving
outstanding levels of customer service and adapting to many and frequent changes in banking as well as local or regional economies.
Failure to excel in these areas could significantly weaken the Company’s competitive position, which could adversely affect the
Company’s growth and profitability. These weaknesses could have a significant negative impact on the Company’s business, financial
condition, and results of operations.
The Company is a community bank and its ability to maintain its reputation is critical to the success of its business and the
failure to do so may materially adversely affect its performance.
The Company is a community bank, and its reputation is one of the most valuable components of its business. As such, the Company
strives to conduct its business in a manner that enhances its reputation. This is done, in part, by recruiting, hiring and retaining
employees who share the Company’s core values: being an integral part of the communities the Company serves; delivering superior
service to the Company’s customers; and caring about the Company’s customers and associates. If the Company’s reputation is
negatively affected, by the actions of its employees or otherwise, its business and operating results may be adversely affected.
The Company is subject to interest rate risk, and a change in interest rates could have a negative effect on its net income.
The Company’s earnings and cash flows are largely dependent upon the Company’s net interest income. Interest rates are highly
sensitive to many factors that are beyond the Company’s control, including general economic conditions, the Company’s competition
and policies of various governmental and regulatory agencies, particularly the Federal Reserve. Changes in monetary policy could
influence Company earnings. Such changes could also affect the Company’s ability to originate loans and obtain deposits as well as
the average duration of the Company’s securities portfolio. If the interest rates paid on deposits and other borrowings increase at a
faster rate than the interest rates received on loans and other investments, the Company’s net interest income, and therefore earnings,
could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall
more quickly than the interest rates paid on deposits and other borrowings.
Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of
changes in interest rates on the Company’s results of operations, any substantial, unexpected, prolonged change in market interest rates
could have a material adverse effect on the Company’s financial condition and results of operations.
22
If the Company fails to maintain sufficient capital, whether due to losses, an inability to raise additional capital or otherwise, its
financial condition, liquidity and results of operations, as well as its ability to maintain regulatory compliance, would be
adversely affected.
The Company and the Bank must meet minimum regulatory capital requirements and maintain sufficient liquidity. Bank capital is
impacted by dividends paid by the Bank to the Company. The Company also faces significant capital and other regulatory
requirements as a financial institution. The Company’s ability to raise additional capital, when and if needed, will depend on
conditions in the economy and capital markets, and a number of other factors – including investor perceptions regarding the Company,
banking industry and market condition, and governmental activities – many of which are outside the Company’s control, and on the
Company’s financial condition and performance. If the Company fails to meet these capital and other regulatory requirements, its
financial condition, liquidity and results of operations could be materially and adversely affected.
The Company could experience an unexpected inability to obtain needed liquidity.
Liquidity measures the ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution
reflects its ability to meet loan requests, to accommodate possible outflows in deposits, and to take advantage of interest rate market
opportunities and is essential to a financial institution’s business. The ability of a financial institution to meet its current financial
obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds. The
Company seeks to ensure that its funding needs are met by maintaining an appropriate level of liquidity through asset and liability
management. In 2015, the Bank also secured liquidity under the advance program provided under terms offered by the Federal Home
Loan Bank of Chicago. If the Company or the Bank becomes unable to obtain funds when needed, it could have a material adverse
effect on its business, financial condition and results of operations.
Loss of customer deposits due to increased competition could increase the Company’s funding costs.
The Company relies on bank deposits to be a low cost and stable source of funding. All federal prohibitions on the ability of financial
institutions to pay interest on business demand deposit accounts were repealed as part of the Dodd-Frank Act, and, as a result, some
financial institutions offer demand deposits to compete for customers. The Company competes with banks and other financial services
companies for deposits. If the Company’s competitors raise the rates they pay on deposits in response to interest rate changes initiated
by the Federal Reserve Bank Open Market Committee or for other reasons of their choice, the Company’s funding costs may increase,
either because the Company raises its rates to avoid losing deposits or because the Company loses deposits and must rely on more
expensive sources of funding. Higher funding costs could reduce the Company’s net interest margin and net interest income and could
have a material adverse effect on the Company’s financial condition and results of operations.
The Company’s estimate of fair values for its investments may not be realizable if it were to sell these securities today.
The Company’s available-for-sale securities are carried at fair value. The Company’s held-to-maturity securities are carried at
amortized cost.
The determination of fair value for securities categorized in Level 3 involves significant judgment due to the complexity of the factors
contributing to the valuation, many of which are not readily observable in the market. Recent market disruptions and the resulting
fluctuations in fair value have made the valuation process even more difficult and subjective. If the valuations are incorrect, it could
harm the Company’s financial results and financial condition.
The Company may be materially and adversely affected by the highly regulated environment in which the Company operates.
The Company is subject to extensive federal and state regulation, supervision and examination. Banking regulations are primarily
intended to protect depositors’ funds, FDIC funds, customers and the banking system as a whole, rather than the Company’s
stockholders. These regulations affect the Company’s lending practices, capital structure, investment practices, dividend policy, and
growth, among other things.
As a bank holding company, the Company and the Bank are subject to extensive regulation and supervision, and undergo periodic
examinations by its regulators, who have extensive discretion and authority to prevent or remedy unsafe or unsound practices or
violations of law by banks and bank holding companies. Failure to comply with applicable laws, regulations or policies could result in
sanctions by regulatory agencies, civil monetary penalties, and/or damage to the Company’s reputation, which could have a material
adverse effect on the Company. Although the Company has policies and procedures designed to mitigate the risk of any such
violations, there can be no assurance that such violations will not occur.
A more detailed description of the primary federal and state banking laws and regulations that affect the Company and the Bank is
included in this Form 10-K under the section captioned “Supervision and Regulation” in Item 1. These laws, regulations, rules,
standards, policies and interpretations are constantly evolving and may change significantly over time. For example, on July 21, 2010,
the Dodd-Frank Act was signed into law, which significantly changed the regulation of financial institutions and the financial services
industry. The Dodd-Frank Act, together with the regulations to be developed thereunder, includes provisions affecting large and small
23
financial institutions alike, including several provisions that affect how community banks, thrifts and small bank and thrift holding
companies will be regulated. In addition, the Federal Reserve, in recent years, has adopted numerous new regulations addressing
banks’ overdraft and mortgage lending practices. Further, the CFPB was established, with broad powers to supervise and enforce
consumer protection laws, and additional consumer protection legislation and regulatory activity is anticipated in the future. Any rules
or regulations promulgated by the CFPB may increase our compliance costs and could limit our revenue from certain consumer
products and services.
The Company and its subsidiaries could become subject to claims and litigation pertaining to the Company’s or the Bank’s
fiduciary responsibility.
Customers make claims and on occasion take legal action pertaining to the Company’s performance of its fiduciary responsibilities.
Whether customer claims and legal action related to the Company’s performance of its fiduciary responsibilities are founded or
unfounded, if such claims and legal action are not resolved in a manner favorable to the Company, they may result in significant
financial liability and/or adversely affect the market perception of the Company and its products and services as well as impact
customer demand for those products and services. Any financial liability or reputational damage could have a material adverse effect
on the Company’s business, which, in turn, could have a material adverse impact on its financial condition and results of operations.
Loss of key employees may disrupt relationships with certain customers.
The Company’s business is primarily relationship-driven in that many of its key employees have extensive customer or asset
management relationships. Loss of key employees with such relationships may lead to the loss of business if the customers were to
follow that employee to a competitor or if asset management expertise was not timely replaced. While the Company believes its
relationships with its key personnel are strong, it cannot guarantee that all of its key personnel will remain with the organization. Loss
of such key personnel could have a negative impact on the company’s business, financial condition, and results of operations.
The Company’s information systems may experience an interruption or breach in security and cyber-attacks, all if which could
have a material adverse effect on the Company’s business.
The Company relies heavily on internal and outsourced technologies, communications, and information systems to conduct its
business. Additionally, in the normal course of business, the Company collects, processes and retains sensitive and confidential
information regarding our customers. As the Company’s reliance on technology has increased, so have the potential risks of a
technology-related operation interruption (such as disruptions in the Company’s customer relationship management, general ledger,
deposit, loan, or other systems) or the occurrence of a cyber-attack (such as unauthorized access to the Company’s systems). These
risks have increased for all financial institutions as new technologies emerge, including the use of the Internet and the expansion of
telecommunications technologies (including mobile devices) to conduct financial and other business transactions, as well as the
increased sophistication and activities of organized crime, perpetrators of fraud, hackers, terrorists and others have combined to
increase overall risk.
In addition to cyber-attacks or other security breaches involving the theft of sensitive and confidential information, hackers recently
have engaged in attacks against large financial institutions, particularly denial of service attacks, that are designed to disrupt key
business services, such as customer-facing web sites. The Company operates in an industry where otherwise effective preventive
measures against security breaches become vulnerable as breach strategies change frequently and cyber-attacks can originate from a
wide variety of sources. It is possible that a cyber incident, such as a security breach, may be undetected for a period of time.
However, applying guidance from FFIEC, the Company has identified security risks and employs risk mitigation controls. Following a
layered security approach, the Company has analyzed and will continue to analyze security related to device specific considerations,
user access topics, transaction-processing and network integrity. The Company expects that it will spend additional time and will incur
additional cost going forward to modify and enhance protective measures. Further effort and spending will be required to investigate
and remediate any information security vulnerabilities.
The Company also faces risks related to cyber-attacks and other security breaches in connection with credit card and debit card
transactions that typically involve the transmission of sensitive information regarding the Company’s customers through various third
parties, including merchant acquiring banks, payment processors, payment card networks and its processors. Some of these parties have
in the past been the target of security breaches and cyber-attacks, and because the transactions involve third parties and environments
such as the point of sale that the Company does not directly control or secure, future security breaches or cyber-attacks affecting any of
these third parties could impact the Company and in some cases the Company may have exposure and suffer losses for breaches or
attacks. Despite third-party security risks that are beyond our control, the Company offers its customers protection against fraud and
attendant losses for unauthorized use of debit cards in order to stay competitive in the market place. Offering such protection exposes
the Company to potential losses which, in the event of a data breach at one or more retailers of considerable magnitude, may adversely
affect its business, financial condition, and results of operation. Further cyber-attacks or other breaches in the future, whether affecting
the Company or others, could intensify consumer concern and regulatory focus and result in reduced use of payment cards and
increased costs, all of which could have a material adverse effect on the Company’s business. To the extent we are involved in any
future cyber-attacks or other breaches, the Company’s reputation could be affected with a potentially material adverse effect on the
Company’s business, financial condition or results of operations.
24
The Company is dependent upon outside third parties for the processing and handling of Company records and data.
The Company relies on software developed by third party vendors to process various Company transactions. In some cases, the
Company has contracted with third parties to run their proprietary software on behalf of the Company at a location under the control of
the third party. These systems include, but are not limited to, payroll, wealth management record keeping, and securities portfolio
management. While the Company performs a review of controls instituted by the vendor over these programs in accordance with
industry standards and institutes its own user controls, the Company must rely on the continued maintenance of the performance
controls by the outside party, including safeguards over the security of customer data. In addition, the Company creates backup copies
of key processing output daily in the event of a failure on the part of any of these systems. Nonetheless, the Company may incur a
temporary disruption in its ability to conduct its business or process its transactions, or incur damage to its reputation if the third party
vendor fails to adequately maintain internal controls or institute necessary changes to systems. Such disruption or breach of security
may have a material adverse effect on the Company’s financial condition and results of operations.
The Company and its subsidiaries are defendants in a variety of litigation and other actions.
Currently, there are certain other legal proceedings pending against the Company and its subsidiaries in the ordinary course of business.
While the outcome of any legal proceeding is inherently uncertain, based on information currently available, the Company’s
management believes that any liabilities arising from pending legal matters would not have a material adverse effect on the Bank or on
the consolidated financial statements of the Company. However, if actual results differ from management’s expectations, it could have
a material adverse effect on the Company’s financial condition, results of operations, or cash flows.
Risks Associated with the Company’s Common Stock
The Company has not established a minimum dividend payment level, and it cannot ensure its ability to pay dividends in the
future.
For several years prior to January 2014, the Company was under a Written Agreement with the Federal Reserve which included among
other things restrictions on the Company’s payment of dividends on its common stock. Although the Written Agreement was
terminated in January 2014, the Company has not yet paid dividends or its common stock and has not determined when it will be in a
position to resume paying dividends or at what level it will be able to pay.
Despite the termination of the Written Agreement, the Company is still subject to various restrictions on its ability to pay dividends
imposed by the Federal Reserve. The Company is also subject to the limitations of the Delaware General Corporation Law (the
“DGCL”). The DGCL allows the Company to pay dividends only out of its surplus (as defined and computed in accordance with the
provisions of the DGCL) or, if the Company has no such surplus, out of its net profits for the fiscal year in which the dividend is
declared and/or the preceding fiscal year.
Holders of the Company’s common stock are also only entitled to receive such dividends as the Company’s board of directors may
declare out of funds legally available for such payments.
The holders of the Company’s debt have rights that are senior to those of its stockholders.
The Company currently has a $45.5 million credit facility with a correspondent lender, which includes $45.0 million of subordinated
debt and $500,000 in term debt. As of December 31, 2014, and December 31, 2015, the $45.0 million in principal of subordinated debt
and the $500,000 in principal of term debt were outstanding. The term debt and subordinated debt mature on March 31, 2018. The
term debt portion of the senior debt is secured by all of the capital stock of the Bank.
The rights of the holders of the Company’s senior debt, subordinated debt and junior subordinated debentures are senior to the shares of
its common stock and preferred stock. As a result, the Company must make payments on its senior debt, subordinated debt and junior
subordinated debentures (and the related Trust Preferred Securities) before any dividends can be paid on its common stock or preferred
stock and, in the event of its bankruptcy, dissolution or liquidation, the holders of the Company’s senior debt, subordinated debt and
junior subordinated debentures must be satisfied before any distributions can be made to its common stockholders.
The trading volumes in the Company’s common stock may not provide adequate liquidity for investors.
Shares of the Company’s common stock are listed on the Nasdaq Global Select Market; however, the average daily trading volume in
its common stock is less than that of most larger financial services companies. A public trading market having the desired
characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of a sufficient number of willing buyers
and sellers of the common stock at any given time. This presence depends on the individual decisions of investors and general
economic and market conditions over which the Company has no control. Given the current daily average trading volume of the
Company’s common stock, significant sales of the Company’s common stock in a brief period of time, or the expectation of these sales,
could cause a significant decline in the price of the Company’s stock.
25
The trading price of the Company’s common stock may be subject to continued significant fluctuations and volatility.
The market price of the Company’s common stock could be subject to significant fluctuations due to, among other things:
actual or anticipated quarterly fluctuations in its operating and financial results, particularly if such results vary from
the expectations of management, securities analysts and investors, including with respect to further loan losses the
Company may incur;
announcements regarding significant transactions in which the Company may engage;
market assessments regarding such transactions;
changes or perceived changes in its operations or business prospects;
legislative or regulatory changes affecting its industry generally or its businesses and operations;
the failure of general market and economic conditions to stabilize and recover, particularly with respect to economic
conditions in Illinois, and the pace of any such stabilization and recovery;
the operating and share price performance of companies that investors consider to be comparable to the Company;
future offerings by the Company of debt, preferred stock or trust preferred securities, each of which would be senior
to its common stock upon liquidation and for purposes of dividend distributions;
actions of its current shareholders, including future sales of common stock by existing shareholders and its directors
and executive officers; and
other changes in U.S. or global financial markets, economies and market conditions, such as interest or foreign
exchange rates, stock, commodity, credit or asset valuations or volatility.
Stock markets in general, and the Company’s common stock in particular, have experienced significant volatility since 2007 and
continue to experience significant price and volume volatility. As a result, the market price of the Company’s common stock may
continue to be subject to similar market fluctuations that may or may not be related to its operating performance or prospects. Increased
volatility could result in a decline in the market price of the Company’s common stock.
Certain banking laws and the Company’s Rights Plan may have an anti-takeover effect.
Certain federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire the
Company, even if doing so would be perceived to be beneficial to the Company’s shareholders. In addition, the Company’s Amended
and Restated Rights Plan and Tax Benefits Preservation Plan (the “Rights Plan”) is intended to discourage any person from acquiring
5% or more of the Company’s outstanding stock (with certain limited exceptions). The Company amended the Rights Plan in
connection with the public offering of 15,525,000 shares of its common stock, which closed on April 3, 2014, to allow two investors in
the offering to acquire more than 5% of the Company’s common stock. The Company cannot guarantee that it will allow any other
holders of its common stock to acquire shares in access of the limits set forth in the Rights Plan. The combination of these provisions
may inhibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of the
Company’s common stock.
Item 1B. Unresolved Staff Comments
None
Item 2. Properties
The principal business office of the Company is located at 37 South River Street, Aurora, Illinois. We conduct our business at 24 retail
banking center locations in various communities throughout the greater western and southern Chicago metropolitan area. . We own 23
locations and lease the other location. The Company’s leased location is under lease through March 2018. We believe that all of our
properties and equipment are well maintained, in good operating condition and adequate for all of our present and anticipated needs.
The total net book value of our premises and equipment (including land and land improvements, buildings, furniture and equipment,
and buildings and leasehold improvements) at December 31, 2015, was $39.6 million.
Item 3. Legal Proceedings
The Company and its subsidiaries have, from time to time, collection suits and other actions that arise in the ordinary course of business
against its borrowers and are defendants in legal actions arising from normal business activities. Management, after consultation with
legal counsel, believes that the ultimate liabilities, if any, resulting from these actions will not have a material adverse effect on the
financial position of the Bank or on the consolidated financial position of the Company.
Item 4. Mine Safety Disclosures
Not applicable.
26
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market for the Company’s Common Stock
The Company’s common stock trades on The Nasdaq Global Select Market under the symbol “OSBC”. As of December 31, 2015, the
Company had 938 stockholders of record of its common stock. The following table sets forth the range of prices during each quarter
for 2015 and 2014.
First quarter
Second quarter
Third quarter
Fourth quarter
2015
2014
High Low Dividend High Low Dividend
$
5.85
6.96
6.79
8.14
$
5.06
5.42
5.93
5.98
$
-
-
-
-
$
5.27
5.02
5.25
5.45
$
4.33
4.53
4.60
4.47
$
-
-
-
-
The Company incorporates by reference the information contained Item 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations under the caption “Capital”.
The Company also incorporates by reference the information contained under the “Notes to Consolidated Financial Statements Note
15: Regulatory & Capital Matters”.
The Company did not pay any dividends in 2015 or 2014 as set forth in the table above. The Company’s shareholders are entitled to
receive dividends when, as and if declared by the board of directors out of funds legally available therefor. The Company’s ability to
pay dividends to shareholders is largely dependent upon the dividends it receives from the Bank; however, certain regulatory
restrictions and the terms of its debt and equity securities, limit the amount of cash dividends it may pay.
Form 10-K and Other Information
Transfer Agent/Stockholder Services
Inquiries related to stockholders records, stock transfers, changes of ownership, change of address and dividend payments should be
sent to the transfer agent at the following address:
Old Second Bancorp, Inc.
c/o Shirley Cantrell,
Executive Administrative Department
37 River Street
Aurora, Illinois 60506-4172
(630) 906-2303
scantrell@oldsecond.com
27
Stockholder Return Performance Graph. The following graph indicates, for the period commencing December 31, 2010 and ending
December 31, 2015, a comparison of cumulative total returns for the Company, the Nasdaq Bank Index and the S&P 500. The information
assumes that $100 was invested at the closing price at December 31, 2010 in the common stock of the Company and each index and that
all dividends were reinvested.
Index
Old Second Bancorp, Inc.
NASDAQ Bank
S&P 500
Period Ending
12/31/2010 12/31/2011 12/31/2012 12/31/2013 12/31/2014 12/31/2015
100.00
100.00
100.00
76.47
89.50
102.11
71.76
106.23
118.45
271.76
150.55
156.82
315.88
157.95
178.28
461.18
171.92
180.75
Purchases of Equity Securities By the Issuer and Affiliated Purchasers
There were purchases of 21,579 shares made by or on behalf of the Company of shares of its common stock during the year ended
December 31, 2015, primarily for the payment of taxes relating to the vesting of stock awards.
The following table shows certain information relating to purchases or recapture of common stock for the twelve months ended
December 31, 2015:
Total number of
shares purchased
as part of a
publicly
announced plan
Remaining
number of shares
authorized for
purchase under
the plan
-
-
-
-
Average
price paid
per share
5.39
5.39
$
$
Period
January 1 - January 31, 2015
Total
Total
number
of shares
acquired
21,579
21,579
28
Item 6. Selected Financial Data
Old Second Bancorp, Inc. and Subsidiaries
Financial Highlights
(In thousands, except share data)
Balance sheet items at year-end
Total assets
Total earning assets
Average assets
Loans, gross
Allowance for loan losses
Deposits
Securities sold under agreement to repurchase
Other short-term borrowings
Junior subordinated debentures
Subordinated debt
Note payable
Stockholders’ equity
Results of operations for the year ended
Interest and dividend income
Interest expense
Net interest and dividend income
(Release) provision for loan losses
Noninterest income
Noninterest expense
Income (loss) before taxes
Provision (benefit) for income taxes
Net income (loss)
Preferred stock dividends and accretion
Net income (loss) available to common stockholders
Loan quality ratios
Allowance for loan losses to total loans at end of year
Provision for loan losses to total loans
Net loans charged-off to average total loans
Nonaccrual loans to total loans at end of year
Nonperforming assets to total assets at end of year
Allowance for loan losses to nonaccrual loans
Per share data
Basic earnings (loss)
Diluted earnings (loss)
Common book value per share
$
$
$
2015
2014
2013
2012
2011
$
$
2,077,863
1,862,257
2,065,980
1,133,715
16,223
1,759,086
34,070
15,000
58,378
45,000
500
155,929
68,164
9,076
59,088
(4,400)
29,294
68,421
24,361
8,976
15,385
1,873
13,512
1.43 %
(0.39) %
0.09 %
1.27 %
1.62 %
112.75 %
2,061,787
1,832,714
2,037,399
1,159,332
21,637
1,685,055
21,036
45,000
58,378
45,000
500
194,163
68,044
10,984
57,060
(3,300)
29,216
73,679
15,897
5,761
10,136
(1,719)
11,855
1.87 %
(0.28) %
0.21 %
2.32 %
2.86 %
80.36 %
$
$
2,004,034
1,758,582
1,962,688
1,101,256
27,281
1,682,128
22,560
5,000
58,378
45,000
500
147,692
69,040
13,786
55,254
(8,550)
31,183
83,144
11,843
(70,242)
82,085
5,258
76,827
$
$
2.48 %
(0.78) %
0.25 %
3.53 %
4.06 %
70.11 %
2,045,799
1,834,995
1,950,625
1,150,050
38,597
1,717,219
17,875
100,000
58,378
45,000
500
72,552
75,081
15,735
59,346
6,284
37,219
90,353
(72)
-
(72)
4,987
(5,059)
3.36 %
0.55 %
1.56 %
6.74 %
7.58 %
49.79 %
$
$
1,941,418
1,751,662
2,015,464
1,368,985
51,997
1,740,781
901
-
58,378
45,000
500
74,002
85,423
21,473
63,950
8,887
31,062
92,623
(6,498)
-
(6,498)
4,730
(11,228)
3.80 %
0.65 %
2.17 %
9.26 %
11.96 %
41.01 %
$
0.46
0.46
5.29
$
0.46
0.46
4.99
$
5.45
5.45
5.37
$
(0.36)
(0.36)
0.05
(0.79)
(0.79)
0.22
Weighted average diluted shares outstanding
Weighted average basic shares outstanding
Shares outstanding at year-end
29,730,074
29,476,821
29,483,429
25,549,193
25,300,909
29,442,508
14,106,033
13,939,919
13,917,108
14,207,252
14,074,188
14,084,328
14,220,822
14,019,920
14,034,991
The following represents unaudited quarterly financial information for the periods indicated:
Interest income
Interest expense
Net interest income
Release for loan losses
Securities (losses) gains, net
Income before taxes
Net income
Basic earnings per share
Diluted earnings per share
4th
$ 17,056
2,306
14,750
—
—
6,062
3,833
0.13
0.13
2015
3rd
$ 17,072
2,268
14,804
(2,100)
(57)
6,308
3,924
0.12
0.12
2nd
$ 17,170
2,234
14,936
(2,300)
(12)
6,573
4,129
0.12
0.12
2014
1st
$ 16,866
2,268
14,598
—
(109)
5,418
3,499
0.09
0.09
4th
$ 17,498
2,356
15,142
(1,300)
262
4,766
2,989
0.06
0.06
3rd
$ 17,199
2,528
14,671
—
1,231
4,650
2,924
0.06
0.06
2nd
$ 16,643
2,991
13,652
(1,000)
295
3,081
2,021
0.26
0.26
1st
$ 16,704
3,109
13,595
(1,000)
(69)
3,400
2,202
0.04
0.04
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
The following discussion provides additional information regarding the Company’s operations for the twelve-month periods ending
December 31, 2015, 2014 and 2013, and financial condition at December 31, 2015 and 2014. This discussion should be read in
29
conjunction with “Selected Financial Data” and the Company’s consolidated financial statements and the accompanying notes thereto
included or incorporated by reference elsewhere in this document.
The Company provides a wide range of financial services through its 24 branch locations located in Kane, Kendall, DeKalb, DuPage,
LaSalle, Will and Cook counties in Illinois. These banking centers offer access to a full range of traditional retail and commercial
banking services including treasury management operations as well as fiduciary and wealth management services. The Company
focuses its business upon establishing and maintaining relationships with its clients while maintaining a commitment to providing for
the financial services needs of the communities in which it operates through its retail branch network. The Company emphasizes
relationships with individual customers as well as small to medium-sized businesses throughout our market area. The Company’s
market area includes a mix of commercial and industrial, real estate, and consumer related lending opportunities, and provides a stable,
loyal core deposit base. The Company also has extensive wealth management services, which includes a registered investment
advisory platform in addition to trust administration and trust services related to personal and corporate trusts, including employee
benefit plan administration services.
The health of the overall real estate market in the Company’s markets continued to improve in 2015. While the precipitous decline in
the value of certain real estate assets slowed in the latter part of 2010, continued difficult market conditions generated smaller declines
in the 2015 values of real estate and associated asset types with overall stable market conditions during the reporting period that ended
December 31, 2015. The availability of ready local markets for real estate, while improved, remained limited and continued to affect
the ability of many borrowers to pay on their obligations. The Company’s net income for 2015 was $15.4 million, $10.1 million in
2014 and $82.1 million in 2013 with 2013 results derived largely from tax related benefits.
In 2015, the Company recorded net income of $15.4 million, or $0.46 per diluted share, which compares with a net income of $10.1
million, or $0.46 per diluted share in 2014 and net income of $82.1 million or $5.45 per diluted share in 2013. The basic earnings per
share was $0.46 in 2015, $0.46 in 2014, and $5.45 in 2013. The Company recorded a $4.4 million release of reserves for loan losses in
2015, compared to $3.3 million release of reserves for loan losses in 2014 and $8.6 million release of reserves for loan losses in 2013.
Net charge-offs were $1.0 million during 2015, $2.3 million during 2014 and $2.8 million during 2013. The net income available to
common stockholders was $13.5 million for the year ended December 31, 2015, $11.9 million for the year ended December 31, 2014
and $76.8 million for the year ended December 31, 2013.
Net interest and dividend income increased 3.6% for the year ended December 31, 2015 compared to the year ended
December 31, 2014. Average loans, including loans held-for-sale increased 2.0% in 2015 compared to 2014. Average interest bearing
liabilities increased $5.7 million or 0.39% while at the same time the average rate decreased 14 basis points. This decrease was
primarily due to reduced time or certificates of deposit while noninterest bearing deposits increased.
In 2014, net interest income of $57.1 million increased $1.8 million from $55.3 million in 2013.
In 2014 and 2015, the Bank continued to reposition its balance sheet to further reduce asset quality risk and increase lending.
Management also continued to emphasize credit quality and maintain its capital ratios with continued strong liquidity. In 2015, loans
decreased 2.2% after growth of 5.3% in 2014 and a 4.2% decline in 2013. The Company also continued to take steps to cut operating
expenses and increase net earnings. Under this overarching approach, the Company significantly reduced problem loans and
nonperforming assets. Reduced other real estate owned holdings resulted in lower property valuation and maintenance expenses in
both 2015 and 2014. As the Company focused on reducing all noninterest expenses, it was able to maintain its profitable wealth
management business and extensive residential real estate business as important sources of noninterest income.
The Company’s primary deposit products are checking, NOW, money market, savings, and certificate of deposit accounts, and the
Company’s primary lending products are commercial mortgages, construction lending, commercial loans, residential mortgages and
consumer loans. Major portions of the Company’s loans are secured by various forms of collateral including real estate, business
assets, and consumer property although borrower cash flow is the primary source of repayment at the time of loan origination.
As discussed, under this approach, net interest and dividend income increased $2.0 million, or 3.6%, in 2015 from $57.1 million for the
year ended 2014. Average earning assets increased from $1.80 billion in 2014 to $1.84 billion in 2015. Average loans, including loans
held-for-sale during the year, increased to $1.15 billion for 2015 from $1.13 billion for 2014. In 2015, loan volumes reflected a
continued low level of qualified borrower demand within the Company’s market areas and charge-off activity. Average interest
bearing liabilities were essentially unchanged at $1.45 billion in 2015 and 2014, as the need for funding remained low with the
stabilization in assets.
Application of critical accounting policies
The Company’s consolidated financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”)
and follow general practices within the banking industry. Application of these principles requires management to make estimates,
assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These
estimates, assumptions, and judgments are based on information available as of the date of the consolidated financial statements.
30
Future changes in information may affect these estimates, assumptions, and judgments, which, in turn, may affect amounts reported in
the consolidated financial statements.
Significant accounting policies are presented in Note 1 of the financial statements included in this annual report. These policies, along
with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant
assets and liabilities are valued in the financial statements and how those values are determined.
Management firmly believes that the Company’s accounting policies with respect to the allowance for loan losses is an accounting area
requiring subjective or complex judgments very important to the Company’s financial position and results of operations. Therefore, the
allowance policy is one of the Company’s most critical accounting policies. The allowance for loan losses represents management’s
estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered
a critical accounting estimate because it requires significant judgment. The amounts of estimated losses on pools of homogeneous
loans are based on historical loss experience, consideration of current economic trends and conditions, as well as estimated collateral
valuations, all of which may be susceptible to significant change. Management incorporated methodology changes in the allowance for
loan losses calculation in 2015. These methodology changes are described in the Allowance for Loan Losses section of this
Management Discussion and Analysis of Financial Condition and Results of Operations. As a result of management’s analysis of the
adequacy of the allowance for loan losses, loan loss reserve releases were recorded during the years ended December 31, 2015, 2014
and 2013.
The loan portfolio represents the largest asset class on the consolidated balance sheets. The allowance for loan losses is a valuation
allowance for loan losses, increased by the provision for loan losses and decreased by both loan loss reserve releases and charge-offs
less recoveries. Management estimates the allowance balance required using an assessment of various risk factors including, but not
limited to, past loan loss experience, known and inherent risks in the portfolio, information about specific borrower situations,
estimated collateral values, volume trends in delinquencies, nonaccruals, economic conditions, and other credit market considerations.
Allocations of the allowance may be made for specific loans, but the entire allowance is available for losses inherent in the loan
portfolio.
A loan is considered impaired when it is probable that not all contractual principal or interest due will be received according to the
original terms of the loan agreement. Management defines the measured value of an impaired loan based upon the present value of the
future cash flows, discounted at the loan’s original effective interest rate, or the fair value reflecting costs to sell the underlying
collateral, if the loan is collateral dependent. Impaired loans were $20.9 million at December 31, 2015. This total compares to $35.9
million and $46.6 million December 31, 2014 and 2013, respectively. In addition, a discussion of the factors driving changes in the
amount of the allowance for loan losses is included in the Allowances for Loan Losses section that follows.
The Company recognizes expense for federal and state income taxes currently payable as well as deferred federal and state taxes,
estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in the
consolidated balance sheets, as well as loss carryforwards and tax credit carryforwards. The Company maintained deferred tax assets
for deductible temporary differences, the largest of which related to the goodwill amortization/impairment. For income tax return
purposes this relates to Section 197 goodwill amortization and goodwill impairment charges. Realization of deferred tax assets is
dependent upon generating sufficient taxable income in either the carryforward or carryback periods to cover net operating losses
generated by the reversal of temporary differences.
Future issuances or sales of common stock or other equity securities could also result in an “ownership change” as defined for U.S.
federal income tax purposes. If an ownership change were to occur, the Company could realize a loss of a portion of its U.S. federal
and state deferred tax assets, including certain built-in losses that have not been recognized for tax purposes, as a result of the operation
of Section 382 of the Internal Revenue Code of 1986, as amended. The amount of the permanent loss would be determined by the
annual limitation period and the carryforward period (generally up to 20 years for federal net operating losses) and any resulting loss
could have a material adverse effect on the results of operations and financial condition. On September 12, 2012, the Company and the
Bank, as rights agent, entered into a Rights Plan which was designed to protect the Company’s deferred tax assets against an
unsolicited ownership change.
On September 2, 2015, the Company and the Bank, as Rights Agent, entered into a Second Amendment to the Amended and Restated
Rights Agreement and Tax Benefits Preservation Plan (the “Amendment”). The Amendment, which will be submitted to the
Company’s shareholders for ratification at the Company’s 2016 annual meeting, extended the final expiration date of the Company’s
Amended and Restated Rights Agreement and Tax Benefits Preservation Plan from September 12, 2015 to September 12, 2018. The
purpose of the Rights Plan is to protect the Company’s deferred tax asset against an unsolicited ownership change, which could
significantly limit the Company’s ability to utilize its deferred tax assets. For a description of the Rights Plan, please refer to the
Company’s Form 8-A, filed September 2, 2015 and Exhibit 4.1 filed on Form 8-K September 2, 2015 also.
Income tax returns are also subject to audit by the Internal Revenue Service (the “IRS”) and state taxing authorities. Income tax
expense for current and prior periods is subject to adjustment based upon the outcome of such audits. All audit work by the IRS has
been completed through and including 2011. The Company believes it has adequately accrued for all probable income taxes payable.
All audit work by the Illinois Department of Revenue or the State of Illinois has been completed through 2010.
31
Another of the Company’s critical accounting policies relates to the fair value measurement of various nonfinancial and financial
instruments including investment securities, valuation of OREO, derivative instruments and the expanded fair value measurement
disclosures that are related to Accounting Standards Codification (“ASC”) 820-10 in detail in Notes 1 and 17 to the consolidated
financial statements included in this annual report.
Results of operations
Net interest income
Net interest income increased $2.0 million, from the year ended December 31, 2014, to $59.1 million for the year ended December 31,
2015. The Company realized modest improvements in interest income and more substantial net interest income benefit in reduced
interest expense. Net interest income increased 3.6% in 2015 compared to 2014. Net interest income increased $1.8 million, from
$55.3 million for the year ended December 31, 2013, to $57.1 million for the year ended December 31, 2014.
Average earning assets increased $44.7 million in 2015 compared to 2014 including a year over year $22.0 million increase in average
loans including loans held-for-sale. Results reflect some increased loan volume during periods of 2015. Average earning assets
increased $36.3 million, or 2.1% in 2014, from $1.76 billion for the year ended December 31, 2013, to $1.80 billion for the year ended
December 31, 2014, as a result of growth in both securities volume and loan volume during 2014. Management continues to develop
loan pipelines that can be expected to generate future loan originations and loan growth.
The Company’s net interest income can be significantly influenced by a variety of factors, including overall loan demand, economic
conditions, credit risk, the amount of nonearning assets including nonperforming loans and OREO, the amounts of and rates at which
assets and liabilities reprice, variances in prepayment of loans and securities, early withdrawal of deposits, exercise of call options on
borrowings or securities, a general rise or decline in interest rates, changes in the slope of the yield-curve, and balance sheet growth or
contraction. The Company’s asset and liability committee (“ALCO”) seeks to manage interest rate risk under a variety of rate
environments by structuring the Company’s balance sheet and off-balance sheet positions. This process is discussed in more detail in
the interest rate risk section.
32
ANALYSIS OF AVERAGE BALANCES,
TAX EQUIVALENT INTEREST AND RATES
Years ended December 31, 2015, 2014 and 2013
2015
2014
2013
Average
Balance
Interest %
Rate Average
Balance
Interest %
Rate Average
Balance
Rate
Interest %
20,066
$
55 0.27 $
28,106
$
73 0.26 $
43,801
$
108 0.24
642,132
22,311
664,443
8,545
1,149,590
1,842,644
29,659
(19,323)
213,000
$ 2,065,980
14,037 2.19
834 3.74
14,871 2.24
306 3.58
616,187
16,425
632,612
9,677
53,327 4.58 1,127,590
1,797,985
68,559 3.68
32,628
-
-
(24,981)
-
-
231,767
-
-
$ 2,037,399
14,131 2.29
727 4.43
14,858 2.35
309 3.19
586,188
14,616
600,804
10,629
53,170 4.65 1,106,447
1,761,681
68,410 3.76
26,871
-
-
(35,504)
-
-
209,640
-
-
$ 1,962,688
11,692 1.99
904 6.19
12,596 2.10
304 2.86
56,417 5.03
69,425 3.90
-
-
-
-
-
-
$
345,472
292,725
249,570
410,691
1,298,458
28,194
21,945
58,378
45,000
500
1,452,475
429,403
10,712
173,390
$ 2,065,980
$
300 0.09 $
282 0.10
152 0.06
3,201 0.78
3,935 0.30
3 0.01
30 0.13
4,287 7.34
814 1.78
7 1.38
9,076 0.62
-
-
-
-
-
-
314,212
305,595
238,326
446,133
1,304,266
26,093
12,534
58,378
45,000
500
1,446,771
388,295
20,218
182,115
$ 2,037,399
$
266 0.08 $
317 0.10
155 0.07
4,500 1.01
5,238 0.40
3 0.01
16 0.13
4,919 8.43
792 1.74
16 3.16
10,984 0.76
-
-
-
-
-
-
290,998
318,343
226,404
493,855
1,329,600
23,313
15,849
58,378
45,000
500
1,472,640
362,871
36,063
91,114
$ 1,962,688
$
255 0.09
443 0.14
161 0.07
6,774 1.37
7,633 0.57
3 0.01
25 0.16
5,298 9.08
811 1.78
16 3.16
13,786 0.94
-
-
-
-
-
-
$ 59,483
$ 57,426
$ 55,639
3.23
3.19
3.16
Assets
Interest bearing deposits with financial institutions $
Securities:
Taxable
Non-taxable (TE)
Total securities
Dividends from Reserve Bank and FHLBC stock
Loans and loans held-for-sale1
Total interest earning assets
Cash and due from banks
Allowance for loan losses
Other noninterest bearing assets
Total assets
Liabilities and Stockholders' Equity
NOW accounts
Money market accounts
Savings accounts
Time deposits
Interest bearing deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Subordinated debt
Notes payable and other borrowings
Total interest bearing liabilities
Noninterest bearing deposits
Other liabilities
Stockholders' equity
Total liabilities and stockholders' equity
Net interest income (TE)
Net interest income (TE)
to total earning assets
Interest bearing liabilities to earning assets
78.83 %
80.47 %
83.59 %
1.
Interest income from loans is shown tax equivalent as discussed below and includes fees of $1.8 million, $2.3 million and $2.5 million for 2015, 2014 and 2013, respectively. Nonaccrual
loans are included in the above stated average balances.
Asset Quality
Nonperforming loans consist of nonaccrual loans, nonperforming restructured accruing loans and loans 90 days or greater past due but
still accruing. Management believes recovery in the overall commercial real estate segment is firmly evident but could be stifled by
macroeconomic events. This change in segment posture would adversely impact Company totals for nonperforming loans. Total
nonperforming loans were $14.6 million at December 31, 2015, down from $27.1 million at December 31, 2014.
Net charge offs of $1.0 million in 2015 compare to $2.3 million in 2014 and $2.8 million in 2013.
33
The following table shows classified loans by segment for the following periods.
(in thousands)
Real estate - construction
Real estate - residential:
Investor
Owner occupied
Revolving and junior liens
Real estate - commercial, nonfarm
Real estate - commercial, farm
Commercial
Other
Classified loans as of December 31,
2013
2014
2015
$
83 $
4,045 $
3,024
Percent Change From
2015-2014 2014-2013
33.8
(97.9)
1,136
7,079
3,055
10,568
1,272
2,029
1
2,263
7,343
3,713
19,170
-
4,403
1
$
25,223 $
40,938 $
9,750
7,699
3,971
37,297
-
481
1
62,223
(49.8)
(3.6)
(17.7)
(44.9)
-
(53.9)
-
(38.4)
(76.8)
(4.6)
(6.5)
(48.6)
-
815.4
-
(34.2)
Classified loans include nonaccrual, performing troubled debt restructurings and all other loans considered substandard. All three
components are down since December 31, 2014. Classified assets include both classified loans and OREO. Management monitors a
ratio of classified assets to the sum of Bank Tier 1 capital and the allowance for loan loss reserve. This ratio reflects another measure
of overall improvement in loan related asset quality. The decline in both classified loans and OREO as well as improved Bank Tier 1
capital in the fourth quarter again strengthened this ratio.
Other positive trends included continued reduction in nonaccrual loans. The December 31, 2015, nonaccrual total of $14.4 million
reflects a trend of reduced nonaccrual loans at year-end that has been experienced since year-end 2010. Similarly, total past due loans,
including accruing and nonaccrual loans, of $12.6 million for year-end 2015 is the most recent decreased year-end total for this metric
in a trend of reductions seen since year-end 2010. Both results reflect aggressive portfolio management process and diligent follow up
by individual relationship managers on specific credits.
Summarizing numerous encouraging developments,
December 31, 2015, after standing at 28.10% at December 31, 2014.
the classified asset ratio showed a positive change
to 20.31% at
Allowance for Loan Losses
The Bank’s allowance for loan losses methodology reasonably estimates loan and lease losses as of the financial statement date(s) and
incorporates management’s current judgments about the credit quality of the loan portfolio through a disciplined and consistently
applied methodology. The methodology follows GAAP including, but not limited to, guidance included in Accounting Standards
Codification (“ASC”) 310 and ASC 450. Analysis is prepared in accordance with guidelines established by the SEC, the Federal
Financial Institutions Examination Council, the American Institution of Certified Public Accountants Audit and Accounting Guide for
Banks and Savings Institutions, and banking industry practices. Methodology is periodically reviewed by the Bank’s independent
accountants and banking regulators. Methodology changes were made in 2015. Beyond these methodology changes, only minor
changes in the risk evaluation factors for commercial loans and commercial real estate credits were made in 2015.
One methodology change reflects use of average balances in historical required reserve calculations to avoid loss rate impact if loan
balances increase or decrease significantly. Previously, period end balances were used in the required reserve calculation. A second
methodology change negates quarterly net recovery data in the historical loss rate experience calculations. The previous treatment of
net recoveries was seen as a less meaningful treatment of current historical loss experience. The last methodology change replaces the
commercial real estate pool management factor with a collateral calculation on balances for special mention and problem accruing
loans in the period. This methodology change more accurately reflects all portfolio risk. The impact of these changes to the ALLL was
an increase of $1.3 million. All calculations conform to U. S. generally accepted accounting principles.
The coverage ratio of the allowance for loan losses to nonperforming loans was 111.0% as of December 31, 2015, which reflects an
increase from 79.9% as of December 31, 2014. A decrease of $12.5 million, or 46.0%, in nonperforming loans in 2015 drove the
overall coverage ratio change. Following established methodology, management updated the estimated specific allocations each
quarter after receiving more recent appraisal valuations or information on cash flow trends related to the impaired credits. General
allocations decreased by $5.2 million from December 31, 2014, while the overall loan balances subject to general factors also decreased
at December 31, 2015. Management determined the estimated amount to include in the allowance for loan losses based upon a number
of factors, including an evaluation of credit market circumstances, loan growth or contraction, the quality and composition of the loan
portfolio and loan loss experience.
Management reviews the performance of the management risk factors including higher risk loan pools rated as special mention and
problem loans, and adjusts the population and the related loss factors taking into account adverse market trends including collateral
valuation as well as its assessments of the credits in that pool. Changes are identified in the Company’s comprehensive loan review
process and made in the related risk factors when needed with a formal affirmation at each quarter end. Those assessments capture
34
management’s estimate of the potential for adverse migration to an impaired status as well as its estimation of what potential valuation
impact would result from that migration. Management has also observed that many stresses in those credits were generally attributable
to cyclical economic events that continue to show some signs of stabilization in 2015.
Management conducts a full annual review of all Home Equity Lines of Credit (“HELOC”) by looking at credit scores and collateral
values. When the Company is notified of a foreclosure on a first mortgage, the HELOC loan is moved to nonaccrual and a decision is
made if the loan is collectible. Loan balances are actively charged-off in the absence of sufficient equity unless the borrower reaffirms
or notifies us of an intention to reaffirm.
The above changes in estimates were made by management to be consistent with observable trends on asset quality within loan
portfolio segments (as discussed in the Asset Quality section above) and in conjunction with market conditions and credit review
administration activities. Several environmental factors are also evaluated monthly, when appropriate, with formal affirmation each
quarter end and are included in the assessment of the adequacy of the allowance for loan losses. Further and importantly, significant
improvement was seen in 2015 net charge-offs and nonperforming loans. Net charge-offs of $2.3 million in 2014 declined by 56.7% to
$1.0 million in 2015. Nonperforming loans of $27.1 million at year-end 2014 declined 46.0% to $14.6 million at December 31, 2015.
Based on this assessment, management determined that an overall improvement in loan asset quality justified loan loss reserve releases
of $4.4 million in 2015. When measured as a percentage of loans outstanding, the total allowance for loan losses decreased from 1.9%
of total loans as of December 31, 2014, to 1.4% of total loans at December 31, 2015. In management’s judgment, an adequate
allowance for estimated losses has been established for inherent losses at December 31, 2015; however, there can be no assurance that
actual losses will not exceed the estimated amounts in the future.
The allowance for loan losses consists of three components: (i) specific allocations established for losses resulting from an analysis
developed through reviews of individual impaired loans for which the recorded investment in the loan exceeds the measured value of
the loan; (ii) reserves based on historical loss experience for each loan category; and (iii) reserves based on general current economic
conditions as well as specific economic and other factors believed to be relevant to the Company’s loan portfolio. The components of
the allowance for loan losses represent an estimation performed pursuant to ASC Topic 450, “Contingencies”, and ASC Topic 310,
“Receivables” including “Accounting by Creditors for Impairment of a Loan – Income Recognition and Disclosures”. See Note 1 on
Summary of Significant Accounting Policies for further detail.
The historical loss experience component is based on actual loss experience for a rolling 20-quarter period and the related internal risk
rating and category of loans charged-off, including any charge-off on TDRs. The loss migration analysis is performed quarterly, and
the loss factors are updated based on actual experience.
Management takes into consideration many internal and external qualitative factors when estimating the additional adjustment for
management factors, including:
Changes in the composition of the loan portfolio, trends in the volume and terms of loans, and trends in delinquent and
nonaccrual loans that could indicate that historical trends do not reflect current conditions.
Changes in credit policies and procedures, such as underwriting standards and collection, charge-off, and recovery practices.
Changes in the experience, ability, and depth of credit management and other relevant staff.
Changes in the quality of the Company’s loan review system and board of directors’ oversight.
Changes in the value of the underlying collateral for collateral-dependent loans.
Changes in the national and local economy that affect the collectability of various segments of the portfolio.
Changes in other external factors, such as competition and legal or regulatory requirements are considered when determining
the level of estimated loss in various segments of the portfolio.
The analysis of these factors involves a high degree of judgment by management. Because of the imprecision surrounding these
factors, the Company estimates a range of inherent losses and maintains a general allowance that is not allocated to a specific category.
In 2015, the general allowance decreased $2.0 million, compared to the decrease of $2.5 million in 2014. Changes in the allowance for
loan losses are detailed in Note 5 on the consolidated financial statements of this report.
35
Noninterest income
(in thousands)
Noninterest Income for the Twelve Months
ending December 31,
2014
2013
2015
Trust income
Service charges on deposits
Residential mortgage banking revenue
Securities (loss) gains, net
Loss on sale of CDO
Total Securities gains (loss), net
Increase in cash surrender value of bank-owned life
insurance
Death benefit realized on bank-owned life insurance
Debit card interchange income
(Loss) gain on disposal and transfer of fixed assets
Other income
$
$
5,953 $
6,820
7,169
(178)
-
(178)
1,221
-
4,028
(1,119)
5,400
29,294 $
6,198 $
7,079
4,424
1,719
-
1,719
1,397
-
3,806
(121)
4,714
29,216 $
6,339
7,256
8,361
2,205
(4,117)
(1,912)
1,603
381
3,458
9
5,688
31,183
Percent Change From
2015-2014 2014-2013
(2.2)
(2.4)
(47.1)
(22.0)
-
189.9
(4.0)
(3.7)
62.0
(110.4)
-
(110.4)
(12.6)
-
5.8
-
14.6
0.3
(12.9)
-
10.1
-
(17.1)
(6.3)
Total noninterest income was essentially unchanged in 2015 from 2014 even though there were several material changes year over
year. While trust income and deposit service charges declined, residential mortgage banking revenue showed strong improvement.
The Company’s residential mortgage operation functioned very efficiently in a difficult rate environment. Also, valuations in the
mortgage business improved year over year. The Company incurred a noncash impairment charge of approximately $1.1 million on
the now closed branch in Batavia, Illinois. The Company also recorded revenue of approximately $917,000 on a one-time payment
from a long term service provider. Last, net losses of securities sales of $178,000 in 2015 compares to net gains on securities sales of
$1.7 million in 2014.
Total noninterest income in 2014 dropped to $29.2 million from $31.2 million in 2013 even after the 2013 $4.1 million loss on the sale
of a collateralized debt obligation is considered. Essentially all operating categories were down year over year, most notably residential
mortgage banking income on slow residential markets in the Company’s selected market areas.
Noninterest expense
(in thousands)
Salaries
Bonus
Benefits and other
Total salaries and employee benefits
Occupancy expense, net
Furniture and equipment expense
FDIC insurance
General bank insurance
Amortization of core deposit intangible asset
Advertising expense
Debit card interchange expense
Legal fees
Other real estate owned expense, net
Other expense
Total noninterest expense
Noninterest Expense for the Twelve Months
ending December 31,
2014
2013
2015
$
$
28,173 $
1,320
5,568
35,061
4,749
4,430
1,334
1,273
-
1,340
1,514
1,175
5,191
12,354
68,421 $
28,440 $
1,955
5,772
36,167
4,963
3,972
2,170
1,561
1,177
1,278
1,631
1,333
6,917
12,510
73,679 $
27,853
2,869
5,966
36,688
5,032
4,264
4,027
2,318
2,099
1,225
1,433
2,066
10,747
13,245
83,144
Percent Change From
2015-2014 2014-2013
2.1
(31.9)
(3.3)
(1.4)
(1.4)
(6.8)
(46.1)
(32.7)
(43.9)
4.3
13.8
(35.5)
(35.6)
(5.5)
(11.4)
(0.9)
(32.5)
(3.5)
(3.1)
(4.3)
11.5
(38.5)
(18.4)
-
4.9
(7.2)
(11.9)
(25.0)
(1.2)
(7.1)
Total noninterest expense decreased by 7.1% in 2015 compared to 2014. Most notably, the Company recorded no amortization
expense on the core deposit intangible in 2015 compared to $1.2 million expense in 2014. Expenses related to the Company’s portfolio
of properties owned as a result of loan foreclosure declined year over year. General bank insurance decreased on the renewal of
company-wide coverages. Salaries and benefits, and FDIC expenses were meaningfully lower year over year. Branch closures in 2014
and 2015 as well as 2015 staff reductions are the main source of this decrease along with strict management attention to control
replacement hiring when positions become open.
36
Total noninterest expense in 2014 dropped to $73.7 million compared to $83.1 million in 2013. Meaningful expense reductions were
attained on the cost of FDIC insurance, general bank insurance and legal fees. The most significant expense reduction was realized in
the cost of the Company’s portfolio of foreclosed properties. These expenses dropped from $10.7 million in 2013 to $6.9 mill ion in
2014.
Income taxes
The Company’s provision for income taxes includes both federal and state income tax expense (benefit). An analysis of the provision
for income taxes for the three years ended December 31, 2015 is detailed in Note 11. The Company income tax accounting policies are
described in Note 1.
Income tax expense totaled $9.0 million for the year ended December 31, 2015 compared to an income tax expense of $5.8 million in
2014 and an income tax benefit of $70.2 million in 2013. Income tax expense reflected all relevant statutory tax rates and GAAP
accounting.
On September 2, 2015, the Company and the Bank, as rights agent (the “Rights Agent”), entered into a Second Amendment to
Amended and Restated Rights Agreement and Tax Benefits Preservation Plan (the “Amendment”), which amended the Amended and
Restated Rights Agreement and Tax Benefits Preservation Plan, dated as of September 12, 2012, between the Company and the Rights
Agent (as amended, the “Tax Benefits Plan”).
The Amendment, which will be submitted to the Company’s stockholders for ratification at the Company’s 2016 annual meeting,
extended the final expiration date of the Tax Benefits Plan from September 12, 2015 to September 12, 2018.
The determination of being able to realize the deferred tax assets is highly subjective and dependent upon judgment concerning
management’s evaluation of both positive and negative evidence, including forecasts of future income, available tax planning
strategies, and assessments of the current and future economic and business conditions. Management considered both positive and
negative evidence regarding the Company’s ability to ultimately realize the deferred tax assets, which is largely dependent upon the
ability to derive benefits based upon future taxable income. As of September 30, 2013, management determined that the realization of
most of the deferred tax asset was “more likely than not” as required by accounting principles and reversed a significant portion of an
established valuation allowance to reflect this judgment.
The Company considered the federal and state net operating loss carryforwards separately when determining if a valuation allowance
was required. After considering tax-planning strategies, the Company reserved a portion of the state net operating loss carryforward
management did not anticipate using by December 31, 2016, based on forecasts made at September 30, 2013. While the state net
operating loss carryforward does not begin to expire until 2021, management acknowledges that forecasts are inherently subjective and
only periods in the foreseeable future should be considered when determining if net deferred tax assets will be utilized. In each future
accounting period, the Company’s management will reevaluate whether the current conditions in conjunction with positive and
negative evidence support a change in the valuation allowance against the Company’s deferred tax assets.
The positive evidence considered included the following: (1) the current quarter results reflect the Company’s sixth consecutive quarter
of pre-tax earnings (2) reduced nonperforming assets for the eleventh consecutive quarter; and (3) strongly encouraging indications
from OCC on the removal of the Consent Order subsequently confirmed with the removal of the Consent Order effective October 17,
2013. Negative evidence considered included the decrease in the Company’s net interest margin and reduced noninterest income,
primarily from decreased mortgage banking income. The only tax planning strategy considered was selling the Company’s bank-
owned life insurance which would have resulted in immediate taxable income of approximately $11.4 million if it had been sold
effective September 30, 2013. While the Company did not complete this sale, management did confirm the sale would have been
considered in the event a deferred tax asset was close to expiration.
There have been no significant changes in the Company's ability to utilize the deferred tax assets through December 31, 2015. The
Company has no valuation reserve on the deferred tax assets as of December 31, 2015.
37
Financial condition
General
Total assets increased $16.1 million, or 0.8%, from December 31, 2014 to close at $2.08 billion as of December 31, 2015. Loans
decreased by 2.2%, to $1.13 billion over the course of 2015. Management continued to emphasize balance sheet stabilization and
credit quality in all lending deliberations and continued to encounter low demand for loans in the Company’s target markets. At the
same time, net loan charge-off activity reduced balances and collateral that previously secured loans moved to OREO. In total, OREO
assets decreased $12.8 million, or 40.2%, for the year ended December 31, 2015 compared to December 31, 2014, as sale activity and
valuation write-downs exceeded new properties added. Total securities increased by $58.7 million, or 9.1%, for the year ended
December 31, 2015, reflecting continued management emphasis on investment securities. Management continued to fund new lending
as well as available-for-sale securities and held-to-maturity securities in 2015 consistent with the Company’s past practice of utilizing
available liquid funds supplemented by short term borrowings from the Federal Home Loan Bank of Chicago (the “FHLBC”). For the
year ended December 31, 2015, large dollar purchases were made in asset-backed securities (almost all backed by student loan assets)
with most other categories essentially unchanged. At December 31, 2015, the largest changes by loan type included increases in
commercial and real estate commercial while holdings of real estate construction and real estate residential loans declined.
Similarly, total assets at year-end 2014 of $2.06 billion were increased slightly from $2.00 billion from year-end 2013. Both loans and
securities increased in the year while other balance sheet items reflected small decreases. Total deposits increased by an insignificant
amount.
Investments
As shown below, net investment purchases during 2015 changed the composition of the Company’s securities portfolio.
(in thousands)
Securities available-for-sale, at fair value
U.S. Treasury
U.S. government agencies
U.S. government agency mortgage-backed
States and political subdivisions
Corporate bonds
Collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Total securities available-for-sale
Securities held-to-maturity, at amortized cost
U.S. government agency mortgage-backed
Collateralized mortgage obligations
Total securities held-to-maturity
Total securities
Securities Portfolio as of December 31,
2013
2014
2015
Percent Change From
2015-2014 2014-2013
$
$
$
$
$
1,509 $
1,556
1,996
30,526
29,400
66,920
231,908
92,251
456,066 $
1,527 $
1,624
-
22,018
30,985
63,627
173,496
92,209
385,486 $
1,544
1,672
-
16,794
15,102
63,876
273,203
-
372,191
36,505 $
211,241
247,746 $
37,125 $
222,545
259,670 $
35,268
221,303
256,571
(1.2)
(4.2)
-
38.6
(5.1)
5.2
33.7
-
18.3
(1.7)
(5.1)
(4.6)
703,812 $
645,156 $
628,762
9.1
(1.1)
(2.9)
-
31.1
105.2
(0.4)
(36.5)
-
3.6
5.3
0.6
1.2
2.6
The Company’s total securities show a net increase of $58.7 million since December 31, 2014. During 2014, holdings in asset-backed
securities (primarily securities backed by student loan paper) declined to be largely replaced by collateralized loan obligations and
corporate bonds. During 2013, net additions of $105.7 million in available-for-sale asset-backed securities (again primarily securities
backed by student loan paper) were offset by reductions in virtually all other available-for-sale categories along with the adoption in
2013 of a held-to-maturity portfolio. In 2015, the Company increased holdings in asset-backed securities (again securities backed by
student loan paper) with only small changes in other categories of securities.
38
Loans
(in thousands)
Commercial
Real estate - commercial
Real estate - construction
Real estate - residential
Consumer
Overdraft
Lease financing receivables
Other
Net deferred loan costs
$
$
$
2013
2014
2015
Major Classification of Loans as of December 31, Percent Change From
2015-2014 2014-2013
25.8
7.2
52.6
(5.1)
27.0
3.3
(20.2)
(9.1)
5.3
52.2
5.3
130,362
605,721
19,806
351,007
4,216
483
10,953
10,130
1,132,678
1,037
119,158
600,629
44,795
370,191
3,504
649
8,038
11,630
1,158,594
738
94,736
560,233
29,351
390,201
2,760
628
10,069
12,793
1,100,771
485
1,101,256
9.4
0.8
(55.8)
(5.2)
20.3
(25.6)
36.3
(12.9)
(2.2)
40.5
(2.2)
1,133,715 $
1,159,332 $
$
Loan production in the fourth quarter of 2015 continued at the slow pace found earlier in the year. A volume increase in commercial
for the year is offset by decreases in real estate loans. Fourth quarter loan production provided a positive close to 2014 and an increase
in loans outstanding from the third quarter. This loan production reflects extensive work done earlier in the year to build business
origination pipelines. Significant new business was realized during the quarter in the multi-family, commercial real estate (both owner
occupied and nonowner occupied) and commercial & industrial classifications. Other commercial real estate credits were realized with
relationships in our targeted customer and geographic markets, in one instance via a participation in a transaction originated by a larger
Illinois based financial institution. Similarly, significant new commercial & industrial lending was realized to businesses that conform
to the Company’s profile of customers defined in Company loan policies. Additionally, we strive to serve customers near our
geographical locations in communities served by the Company. The Company continues to seek opportunities in its primary lending
markets that will develop additional relationship banking customers; however, markets remain very competitive for new loan business.
Total loans were $1.13 billion as of December 31, 2015, a decrease from $1.16 billion as of December 31, 2014. Loan production in
2015 declined as compared to the loan growth seen in 2014. Loan results in 2014 represented an increase of $58.1 million in the year.
While the Company worked diligently to rebuild and build loan origination pipelines during 2014 and 2015, the lack of demand from
qualified borrowers, including borrower reluctance to drawdown on existing credit lines through the year, as well as the competitive
landscape, moderated growth in the loan portfolio. As discussed in the Asset Quality section above, management continued to
emphasize loan portfolio quality in 2015 and, as a result, $1.0 million of net loan charge-offs were recorded in 2015 compared to
$2.3 million of net loan charge-offs recorded in 2014 and $2.8 million in 2013.
The quality of the loan portfolio is in large part a reflection of the economic health of the communities in which the Company operates.
The local economies have been affected by the improved but still difficult economic conditions, referred to by many as structural
headwinds that have been experienced nationwide. The less than vibrant economic conditions continue to affect business regions
served in particular and financial markets generally. Real estate related activity, including valuations and transactions, while improved
from past severe conditions, continues to be less than expansive. Because the Company is located in an area with significant open
space and undeveloped real estate, real estate lending (including commercial, residential, and construction) has been and continues to
be a sizable portion of the portfolio.
Real estate lending categories comprised the largest group in the portfolio as of December 31, 2015 and December 31, 2014. The
commercial loan portfolio increased $11.2 million to $130.4 million at December 31, 2015, from $119.2 million at December 31, 2014.
The Company remains committed to overseeing and managing its loan portfolio to avoid unnecessarily high credit concentrations in
accordance with the general interagency guidance on risk management. Consistent with those commitments, management updated its
asset diversification plan and policy and anticipates that the percentage of real estate lending to the overall portfolio will decrease in the
future.
The allowance for loan losses was $16.2 million at year-end 2015 compared to $21.6 million and $27.3 million at year-end 2014 and
2013, respectively. One measure of the adequacy of the allowance for loan losses is the ratio of the allowance to total loans. The
allowance for loan losses as a percentage of total loans was 1.4% as of December 31, 2015, compared to 1.9% at year-end 2014 and
2.5% as of December 31, 2013. In management’s judgment, an adequate allowance for estimated losses has been established; however,
there can be no assurance that losses will not exceed the estimated amounts in the future.
Management remains cautious about the continued slow recovery in the local and overall economic environment. Furthermore, the
sustained difficulties in the commercial and investor real estate sector, while showing signs of improvement, could continue to
adversely affect collateral values. These events may adversely affect cash flows generally for both commercial and individual
borrowers. While portfolio stability has taken hold, the Company could experience undesirable levels of problem assets, delinquencies,
and losses on loans in future periods if economic recession or politically triggered economic instability develops.
39
Other Real Estate Owned
OREO decreased $12.8 million from $32.0 million at December 31, 2014 to $19.1 million at December 31, 2015. Of note, the year-
end 2015 total includes $468,000 related to a building formerly occupied by a Bank branch, now closed, in Batavia, Illinois. The Bank
recorded a loss of approximately $1.1 million upon the transfer of this property to OREO. A similar reduction in overall holdings is
seen at December 31, 2014 compared to December 31, 2013. The Company has successfully managed the reduction of OREO
holdings from a total of $93.3 million at December 31, 2011. The trend of year over year reductions in valuation adjustments continued
but at a lower level in 2015 compared to 2014.
(in thousands)
Single family residence
Lots (single family and commercial)
Vacant land
Multi-family
Commercial property
Total OREO properties
$
2014
2015
2013
2,621 $
2,334 $
OREO Properties by Type as of December31, Percent Change From
2015-2014 2014-2013
(43.7)
(11.9)
(13.1)
(13.1)
(30.0)
(23.0)
13,235
2,725
1,549
11,852
31,982 $
4,658
15,020
3,135
1,783
16,941
41,537
(11.0)
(24.1)
(22.8)
(79.7)
(63.3)
(40.2)
10,042
2,104
314
4,347
19,141 $
$
The OREO valuation reserve ended 2015 at $14.1 million, which was 42.5% of gross OREO at year-end 2015. This compares to $19.2
million, or 37.5% of gross OREO at year-end 2014.
Deposits & Borrowings
In 2015, the Company grew total deposits by $74.0 million, or 4.4%, to a total of $1.76 billion at year-end 2015. A reduced level of
time or certificates of deposits as higher yielding certificates matured in the current lower rate environment was offset by larger
increases in transactional demand, money market and savings account balances. These results compare to results in 2014 when the
Company saw virtually unchanged total deposits of $1.68 billion from year-end 2013 to December 31, 2014. Notably, time deposits or
certificates of deposit dropped as renewals took place in a very different rate environment. Availability of other liquidity sources
reduced the need for deposit funding.
The Company’s most significant borrowing relationship continued to be the $45.5 million credit facility with a correspondent bank.
The credit facility was originally composed of a $30.5 million senior debt facility, which included $500,000 in term debt, and $45.0
million of subordinated debt. The Company had remaining debt of $500,000 in principal outstanding in term debt, and $45.0 million in
principal outstanding in subordinated debt under that facility at the end of December 31, 2015, and December 31, 2014. The term debt
is secured by all of the outstanding capital stock of the Bank. The subordinated debt and term debt portion of the senior debt facility
mature on March 31, 2018. At December 31, 2015, the Company was in compliance with all of the financial covenants contained
within the credit agreement. The Company has made all required interest payments on the outstanding principal amounts on a timely
basis.
The Company’s borrowings at the FHLBC require the Bank to be a member and invest in the stock of the FHLBC and total borrowings
are generally limited to the lower of 35% of total assets or 60% of the book value of certain mortgage loans. The Bank primarily uses
these borrowings as a source of short-term funding.
Capital
As of December 31, 2015, total stockholders’ equity was $155.9 million, which was a decrease of $38.2 million, or 19.7%, from $194.2
million as of December 31, 2014. This decrease was attributable to the Series B Stock redemption of $47.3 million conducted during
2015. Accumulated other comprehensive loss on securities net of deferred taxes was $7.7 million at December 31, 2014, and $12.7
million at December 31, 2015.
40
Recapping important events from 2014 and relevant history, the Company completed the sale of $32.6 million of cumulative trust
preferred securities by its subsidiary, Old Second Capital Trust I in July 2003. These trust preferred securities remain outstanding for a
30-year term, but subject to regulatory approval, they can be called in whole or in part at the Company’s discretion after an initial five-
year period, which has since passed. The Company does not currently intend to seek regulatory approval to call these securities.
Dividends are payable quarterly at an annual rate of 7.80% and are included in interest expense in the consolidated financial statements
even when deferred. Likewise, the Company issued an additional $25.8 million of cumulative trust preferred securities through a
private placement completed by a second unconsolidated subsidiary, Old Second Capital Trust II in April 2007. These trust preferred
securities also mature in 30 years, but subject to the aforementioned regulatory approval, can be called in whole or in part in 2017.
When not in deferral the quarterly cash distributions on the securities are fixed at 6.77% through June 15, 2017 and float at 150 basis
points over the three-month LIBOR rate thereafter. The Company entered into a forward starting interest rate swap on August 18,
2015, with an effective date of June 15, 2017. This transaction had a notional amount totaling $25.8 million as of December 31, 2015,
was designated as a cash flow hedge of certain junior subordinated debentures and was determined to be fully effective during the
period presented. As such, no amount of ineffectiveness has been included in net income. Therefore, the aggregate fair value of the
swap is recorded in other liabilities with changes in fair value recorded in other comprehensive income, net of tax. The amount
included in other comprehensive income would be reclassified to current earnings should all or a portion of the hedge no longer be
considered effective. The Company expects the hedge to remain fully effective during the remaining term of the swap. The Bank will
pay the counterparty a fixed rate and receive a floating rate based on three month LIBOR. Management concluded that it would be
advantageous to enter into this transaction given that the Company has trust preferred securities that will change from fixed rate to
floating rate on June 15, 2017. The cash flow hedge has a maturity date of June 15, 2037.
The Company is currently paying interest on all trust preferred securities as that interest comes due. As of December 31, 2015, trust
preferred proceeds of $44.1 million qualified as Tier 1 regulatory capital and $12.5 million qualified as Tier 2 regulatory capital. As of
December 31, 2014, trust preferred proceeds of $56.6 million qualified as Tier 1 regulatory capital. Additionally, $18.0 million and
$27.0 million of the $45.0 million in subordinated debt that was obtained to finance the February 2008 acquisition qualified as Tier 2
regulatory capital as of December 31, 2015, and December 31, 2014, respectively.
In January 2009, the Company issued and sold (i) 73,000 shares of Series B Stock and (ii) a warrant to purchase 815,339 shares of its
common stock at an exercise price of $13.43 per share to the Treasury. The total liquidation value of the Series B Stock and the
warrant was $73.0 million at issuance. All of the Series B Stock held by Treasury was sold to third parties, including certain of the
Company’s directors, in public auctions that were completed in the first quarter of 2013. The warrant was also sold at a subsequent
auction to a third party. At December 31, 2014, the Company carried $47.3 million of Series B Stock in total stockholders’
equity. During 2015 the Company redeemed $15.8 million of Series B Stock in the first quarter of 2015 and the remaining shares in the
third quarter of 2015. As of December 31, 2015 the Series B Stock is fully redeemed.
At December 31, 2015, the Bank’s Tier 1 capital leverage ratio was 9.94%, down 208 basis points from December 31, 2014. The
Bank’s total capital ratio was 15.23%, down 350 basis points from December 31, 2014. The Company’s regulatory capital ratios of
Total capital to risk weighted assets, Tier 1 common equity to risk weighted assets, Tier 1 capital to risk weighted assets and Tier 1
capital to average assets decreased to 15.56%, 10.55%, 12.30% and 8.69%, at December 31, 2015, respectively, compared to the
Company’s regulatory capital ratios of Total capital to risk weighted assets, Tier 1 capital to risk weighted assets and Tier 1 capital to
average assets to 17.68%, 14.44% and 9.93%, respectively, at December 31, 2014. The Company, on a consolidated basis, exceeded
the minimum capital ratios to be deemed “well capitalized” at December 31, 2015 pursuant to the capital requirements in effect at that
time. All ratios conform to the regulatory calculation requirements in effect as of the date noted.
At December 31, 2015, and December 31, 2014, the Company, on a consolidated basis, exceeded the minimum thresholds to be
considered “adequately capitalized” under current regulatory defined capital ratios. The Company and the Bank are subject to
regulatory capital requirements administered by federal banking agencies. Generally, if adequately capitalized, regulatory approval is
not required to accept brokered deposits. In addition to the above regulatory ratios, the Company’s non-GAAP tangible common
equity to tangible assets increased from 7.12% at December 31, 2014, to 7.50% at December 31, 2015, largely attributable to the
increased tangible common equity as a result of the redemption of the Series B Stock.
The Company repurchased 21,579 shares for $117,000 in 2015, resulting in an increase in treasury stock to 4,943,805 shares and $96.0
million as of December 31, 2015. The Company repurchased 9,600 shares for $46,000 in 2014, resulting in an increase in treasury
stock to 4,922,226 shares and $95.8 million as of December 31, 2014. Treasury stock repurchased decreases stockholders’ equity, but
also increases earnings per share by reducing the number of shares outstanding. No stock options were exercised in the years ended
December 31, 2015 and 2014.
Liquidity
Liquidity is the Company’s ability to fund operations, to meet depositor withdrawals, to provide for customer’s credit needs, and to
meet maturing obligations and existing commitments. The liquidity of the Company principally depends on cash flows from net
operating activities, including pledging requirements, investment in, and both maturity and repayment of assets, changes in balances of
deposits and borrowings, and its ability to borrow funds. In addition, the Company’s liquidity depends on the Bank’s ability to pay
dividends, which is subject to certain regulatory requirements. See “Supervision and Regulation”. The Company continually monitors
41
its cash position and borrowing capacity as well as performs monthly stress tests of contingency funding as part of its liquidity
management process. Stress testing of liquidity for contingency funding purposes includes tests that outline scenarios for specifically
identified liquidity risk events, which are then aggregated into a Bank-wide assessment of liquidity risk stress levels. The outcomes of
these tests are reviewed by management and the Company’s Board of Directors monthly.
Net cash inflows from operating activities were $21.1 million during 2015, compared with outflows of $6.3 million in 2014 and inflows
of $35.3 million in 2013. Proceeds from sales of loans held-for-sale, net of funds used to originate loans held-for-sale, was a source of
inflows for 2015 and 2014. Interest received, net of interest paid, combined with changes in provision for loan losses, and other assets
and liabilities were a source of outflows for 2015, and 2014. The Company recorded a deferred income tax benefit of $70.4 million
including a DTA reversal for the year ended December 31, 2013. Management of investing and financing activities, as well as market
conditions, determines the level and the stability of net interest cash flows. Management’s policy is to mitigate the impact of changes
in market interest rates to the extent possible as part of the balance sheet management process.
Net cash outflows from investing activities were $32.2 million in 2015, compared to net cash outflows of $66.1 million in 2014 and net
cash inflows of $9.6 million in 2013. In 2015, securities transactions accounted for a net outflow of $65.9 million, net principal
received on loans accounted for net inflows of $16.1 million, and proceeds from the sales of OREO assets accounted for inflows of
$18.8 million. In 2014, securities transactions accounted for a net outflow of $12.8 million, and net principal received on loans
accounted for net outflows of $74.3 million whereas proceeds from the sale of OREO assets accounted for inflows of $22.9 million.
Net cash inflows from financing activities in 2015, were $7.2 million compared with net cash inflows of $69.0 million in 2014, while
2013 had net cash outflows of $125.7 million. Significant cash inflows from financing activities in 2015 included increases of $74.0
million in deposits and $13.0 million in securities sold under repurchase agreements. Significant cash outflows from financing
activities in 2015 include the Series B Stock redemption of $47.3 million, $30.0 million in the reductions of other short-term borrowing
and $2.4 million in dividends paid on the Series B Stock. Significant cash inflows from financing activities in 2014 included the
proceeds from the issuance of common stock of $64.3 million and increases of $40.0 million in other short-term borrowings.
Significant cash outflows from financing activities in 2014 include the Series B Stock redemption of $24.3 million and $12.4 million in
dividends paid on the Series B Stock.
Contractual Obligations, Commitments, Contingent Liabilities, and Off-balance sheet arrangements
The Company has various financial obligations that may require future cash payments. The following table presents, as of
December 31, 2015, significant fixed and determinable contractual obligations (all dollars in thousands) to third parties by payment
date:
Deposits without a stated maturity
Certificates of deposit
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Subordinated debt
Notes payable and other borrowings
Purchase obligations
Automatic teller machine leases
Operating leases
Nonqualified voluntary deferred compensation plan
Total
Within
One Year
$ 1,351,237
155,633
34,070
15,000
-
-
-
671
46
4
92
$ 1,556,753
One to
Three to
Three Years Five Years Five Years
Over
$
$
-
178,258
-
-
-
45,000
500
279
57
-
158
224,252
$
$
-
73,958
-
-
-
-
-
-
15
-
48
74,021
$
-
-
-
-
58,378
-
-
-
-
-
1,325
59,703
$
Total
$ 1,351,237
407,849
34,070
15,000
58,378
45,000
500
950
118
4
1,623
$ 1,914,729
Purchase obligations represent obligations under agreements to purchase goods or services that are enforceable and legally binding on
the Company and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable
price provisions; and the approximate timing of the transaction. The purchase obligation amounts presented above primarily relate to
certain contractual payments for services provided for information technology, capital expenditures, and the outsourcing of certain
operational activities. The Company routinely enters into contracts for services. These contracts may require payment for services to
be provided in the future and may also contain penalty clauses for early termination. In this disclosure, the Company has made an effort
to estimate such payments, where applicable. Additionally, where necessary, all data reflects reasonable management estimates as to
certain purchase obligations as of December 31, 2015. Management has used the information available to make the estimations
necessary to value the related purchase obligations.
Derivative contracts, which include contracts under which the Company either receives cash from, or pays cash to, counterparties
reflecting changes in interest rates are carried at fair value on the consolidated balance sheet as disclosed in Note 19 of the Notes to the
Consolidated Financial Statements provided in Part II, Item 8, “Financial Statements and Supplementary Data”. Because the fair value
42
of derivative contracts changes daily as market interest rates change, the derivative assets and liabilities recorded on the balance sheet at
December 31, 2015, do not necessarily represent the amounts that may ultimately be paid. As a result, these assets and liabilities are
not included in the table of contractual obligations presented above.
Assets under management and assets under custody are held in fiduciary or custodial capacity for clients. In accordance with GAAP,
these assets are not included on the Company’s balance sheet.
Financial instruments with off-balance sheet risk address the financing needs of our clients. These instruments include commitments to
extend credit as well as performance, standby and commercial letters of credit. Further discussion of these commitments is included in
Note 14 of the Notes to Consolidated Financial Statements provided in Part II, Item 8, “Financial Statements and Supplementary Data.”
The following table details the amounts and expected maturities of significant commitments to extend credit as of December 31, 2015:
Commitment to extend credit:
Commercial secured by real estate
Revolving open end residential
Other
Financial standby letters of credit (borrowers)
Performance standby letters of credit (borrowers)
Commercial letters of credit (borrowers)
Performance standby letters of credit (others)
Total
Within
One Year
One to
Three Years Five Years Five Years
Three to Over
Total
$
$
8,473
9,573
116,479
3,572
7,366
47
575
146,085
$
$
7,603
29,896
25,520
55
-
-
-
63,074
$
$
2,189
13,185
440
5
50
-
-
15,869
$
$
4,836
42,343
8,388
-
-
-
-
55,567
$
$
23,101
94,997
150,827
3,632
7,416
47
575
280,595
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Interest rate risk
As part of its normal operations, the Company is subject to interest-rate risk on the assets it invests in (primarily loans and securities)
and the liabilities it funds (primarily customer deposits and borrowed funds), as well as its ability to manage such risk. Fluctuations in
interest rates may result in changes in the fair market values of the Company’s financial instruments, cash flows, and net interest
income. Like most financial institutions, the Company has an exposure to changes in both short-term and long-term interest rates.
In December 2015, the Federal Reserve raised short-term interest rates by 0.25%. It is uncertain whether the Federal Reserve will
move short-term interest rates higher during the course of 2016. Generally, the Federal Reserve action has not had a significant impact
on long-term rates. The Company manages interest rate risk within guidelines established by policy which limits the amount of rate
exposure. In practice, interest rate risk exposure is maintained well within those guidelines and does not pose a material risk to the
future earnings of the Company.
The Company manages various market risks in its normal course of operations, including credit, liquidity risk, and interest-rate risk.
Other types of market risk, such as foreign currency exchange risk and commodity price risk, do not arise in the normal course of the
Company’s business activities and operations. In addition, since the Company does not hold a trading portfolio, it is not exposed to
significant market risk from trading activities. The changes in the Company’s interest rate risk exposures at December 31, 2015, and
December 31, 2014, are outlined in the table below.
The Company's net income can be significantly influenced by a variety of external factors, including: overall economic conditions,
policies and actions of regulatory authorities, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of
loans and securities other than those that are assumed, early withdrawal of deposits, exercise of call options on borrowings or securities,
competition, a general rise or decline in interest rates, changes in the slope of the yield-curve, changes in historical relationships
between indices (such as LIBOR and prime), and balance sheet growth or contraction. The Company's ALCO seeks to manage interest
rate risk under a variety of rate environments by structuring the Company's balance sheet and off-balance sheet positions, which
includes interest rate swap derivatives as discussed in Note 19 of the financial statements included in this annual report. The risk is
monitored and managed within approved policy limits.
The Company utilizes simulation analysis to quantify the impact of various rate scenarios on net interest income. Specific cash flows,
repricing characteristics, and embedded options of the assets and liabilities held by the Company are incorporated into the simulation
model. Earnings at risk is calculated by comparing the net interest income of a stable interest rate environment to the net interest
income of a different interest rate environment in order to determine the percentage change. Significant declines in interest rates that
occurred during the first half of 2012 had made it impossible to calculate valid interest rate scenarios for rate declines of 1.0% or more,
a situation that continues to date. As of December 2014, the Company had modest amounts of earnings gains (in both dollars and
percentage) should interest rates rise. The gains in the rising rate scenarios increased significantly as of December 2015, due to (1) an
interest rate swap to fix the rate on the Company's Old Second Capital Trust II Preferred debt when it changes to floating rate debt in
43
June 2017, (2) increases in adjustable-rate loans and securities and (3) increases in checking deposits whose rates change little when
market interest rates increase. Management considers the current level of interest rate risk to be moderate, but intends to continue
closely monitoring changes in that risk in case corrective actions might be needed in the future. Federal Funds rates and the Bank's
prime rate rose 0.25% in December of 2015, to 0.50% and 3.50%, respectively.
The following table summarizes the effect on annual income before income taxes based upon an immediate increase or decrease in
interest rates of 0.5%, 1%, and 2% and no change in the slope of the yield curve. The -2% and -1% sections of the table do not show
model changes for those magnitudes of decrease due to the low interest rate environment over the relevant time periods.
December 31, 2015
Dollar change
Percent change
December 31, 2014
Dollar change
Percent change
Analysis of Net Interest Income Sensitivity
(2.0) % (1.0) %
Immediate Changes in Rates
0.5 %
(0.5) %
1.0 %
2.0 %
N/A
N/A
N/A
N/A
N/A
N/A
$
(1,058)
$
(1.9) %
711
1.3 %
$ 1,569
$ 3,339
2.8 %
6.1 %
N/A
N/A
$
(718)
(1.2) %
$
264
0.5 %
$ 1,086
$ 2,243
1.9 %
3.9 %
The amounts and assumptions used in the simulation model should not be viewed as indicative of expected actual results. Actual
results will differ from simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market
conditions and management strategies. The above results do not take into account any management action to mitigate potential risk.
Effects of Inflation
In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than
changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not change at the same
rate or in the same magnitude as the inflation rate. Rather, interest rate volatility is based on changes in the expected rate of inflation,
as well as on changes in monetary and fiscal policies. A financial institution’s ability to be relatively unaffected by changes in interest
rates is a good indicator of its capability to perform in today’s volatile economic environment. The Company seeks to insulate itself
from interest rate volatility by using its best efforts to ensure that rate sensitive assets and rate sensitive liabilities respond to changes in
interest rates in a similar time frame and to a similar degree.
44
Item 8. Financial Statements and Supplementary Data
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 2015 and 2014
(In thousands, except share data)
Assets
Cash and due from banks
Interest bearing deposits with financial institutions
Cash and cash equivalents
Securities available-for-sale, at fair value
Securities held-to-maturity, at amortized cost
Federal Home Loan Bank and Federal Reserve Bank stock
Loans held-for-sale
Loans
Less: allowance for loan losses
Net loans
Premises and equipment, net
Other real estate owned
Mortgage servicing rights, net
Bank-owned life insurance (BOLI)
Deferred tax assets, net
Other assets
Total assets
Liabilities
Deposits:
Noninterest bearing demand
Interest bearing:
Savings, NOW, and money market
Time
Total deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Subordinated debt
Notes payable and other borrowings
Other liabilities
Total liabilities
Stockholders’ Equity
Preferred stock
Common stock
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Treasury stock
Total stockholders’ equity
December 31,
December 31,
2015
2014
$
$
26,975
13,363
40,338
456,066
247,746
8,518
2,849
1,133,715
16,223
1,117,492
39,612
19,141
5,847
58,028
64,552
17,674
2,077,863
$
$
30,101
14,096
44,197
385,486
259,670
9,058
5,072
1,159,332
21,637
1,137,695
42,335
31,982
5,462
56,807
70,141
13,882
2,061,787
$
442,639
$
400,447
908,598
407,849
1,759,086
34,070
15,000
58,378
45,000
500
9,900
1,921,934
-
34,427
115,918
114,209
(12,659)
(95,966)
155,929
865,103
419,505
1,685,055
21,036
45,000
58,378
45,000
500
12,655
1,867,624
47,331
34,365
115,332
100,697
(7,713)
(95,849)
194,163
Total liabilities and stockholders’ equity
$
2,077,863
$
2,061,787
December 31, 2015
December 31, 2014
Preferred
Stock
$
Common
Preferred
Common
Stock
Stock
Stock
1 $
1 $
1
1 $
-
300,000
-
-
-
N/A
60,000,000
34,427,234
29,483,429
4,943,805
1,000
300,000
47,331
47,331
-
N/A
60,000,000
34,364,734
29,442,508
4,922,226
Par value
Liquidation value
Shares authorized
Shares issued
Shares outstanding
Treasury shares
See accompanying notes to consolidated financial statements.
45
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Income
Years Ended December 31, 2015, 2014 and 2013
(In thousands, except share data)
Year Ended
December 31,
2014
2015
2013
$
53,035 $
189
52,926 $
133
Interest and dividend income
Loans, including fees
Loans held-for-sale
Securities:
Taxable
Tax exempt
Dividends from Federal Reserve Bank and Federal Home Loan Bank stock
Interest bearing deposits with financial institutions
Total interest and dividend income
Interest expense
Savings, NOW, and money market deposits
Time deposits
Other short-term borrowings
Junior subordinated debentures
Subordinated debt
Notes payable and other borrowings
Total interest expense
Net interest and dividend income
Loan loss reserve release
Net interest and dividend income after provision for loan losses
Noninterest income
Trust income
Service charges on deposits
Secondary mortgage fees
Mortgage servicing gain, net of changes in fair value
Net gain on sales of mortgage loans
Securities (loss) gain, net
Increase in cash surrender value of bank-owned life insurance
Death benefit realized on bank-owned life insurance
Debit card interchange income
(Loss) gain on disposal and transfer of fixed assets, net
Other income
Total noninterest income
Noninterest expense
Salaries and employee benefits
Occupancy expense, net
Furniture and equipment expense
FDIC insurance
General bank insurance
Amortization of core deposit
Advertising expense
Debit card interchange expense
Legal fees
Other real estate expense, net
Other expense
Total noninterest expense
Income before income taxes
Provision for income taxes
Net income
Preferred stock dividends and accretion of discount
Dividends waived upon preferred stock redemption
Gain on preferred stock redemption
Net income available to common stockholders
Basic earnings per share
Diluted earnings per share
See accompanying notes to consolidated financial statements.
14,037
542
306
55
68,164
734
3,201
33
4,287
814
7
9,076
59,088
(4,400)
63,488
5,953
6,820
907
487
5,775
(178)
1,221
-
4,028
(1,119)
5,400
29,294
35,061
4,749
4,430
1,334
1,273
-
1,340
1,514
1,175
5,191
12,354
68,421
24,361
8,976
15,385 $
1,873
-
-
13,512 $
14,131
472
309
73
68,044
738
4,500
19
4,919
792
16
10,984
57,060
(3,300)
60,360
6,198
7,079
621
209
3,594
1,719
1,397
-
3,806
(121)
4,714
29,216
36,167
4,963
3,972
2,170
1,561
1,177
1,278
1,631
1,333
6,917
12,510
73,679
15,897
5,761
10,136 $
5,062
(5,433)
(1,348)
11,855 $
56,193
156
11,692
587
304
108
69,040
859
6,774
28
5,298
811
16
13,786
55,254
(8,550)
63,804
6,339
7,256
821
1,913
5,627
(1,912)
1,603
381
3,458
9
5,688
31,183
36,688
5,032
4,264
4,027
2,318
2,099
1,225
1,433
2,066
10,747
13,245
83,144
11,843
(70,242)
82,085
5,258
-
-
76,827
0.46 $
0.46
0.46 $
0.46
5.45
5.45
$
$
$
46
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
Years Ended December 31, 2015, 2014 and 2013
(In thousands)
Net Income
Year Ended
December 31,
2014
$ 15,385 $ 10,136 $ 82,085
2015
2013
Unrealized holding losses on available-for-sale securities arising during the period
Related tax benefit
Holding losses after tax on available-for-sale securities
(8,624)
3,382
(5,242)
(394)
165
(229)
(11,965)
4,924
(7,041)
Less: Reclassification adjustment for the net (losses) gains realized during the period
Net realized (losses) gains
Income tax benefit (expense) on net realized (losses) gains
Net realized (losses) gains after tax
Other comprehensive loss on available-for-sale securities
Accretion of net unrealized holding gains on held-to-maturity securities transferred from
available-for-sale securities
Related tax expense
Other comprehensive income on held-to-maturity securities
Changes in fair value of derivatives used for cashflow hedges
Related tax benefit
Other comprehensive loss on cashflow hedges
Total other comprehensive loss
Total comprehensive income
See accompanying notes to consolidated financial statements.
(178)
71
(107)
(5,135)
1,719
(704)
1,015
(1,244)
(1,912)
784
(1,128)
(5,913)
964
(396)
568
(631)
252
(379)
968
(399)
569
-
-
-
343
(141)
202
-
-
-
(4,946)
$ 10,439 $
(5,711)
(675)
9,461 $ 76,374
47
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2015, 2014 and 2013
(In thousands)
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization of leasehold improvement
Change in fair value of mortgage servicing rights
Loan loss reserve release
Gain on recapture of restricted stock
Provision for deferred tax expense (benefit)
Originations of loans held-for-sale
Proceeds from sales of loans held-for-sale
Net gain on sales of mortgage loans
Change in current income taxes receivable (payable)
Increase in cash surrender value of bank-owned life insurance
Death claim on bank-owned life insurance
Change in accrued interest receivable and other assets
Change in accrued interest payable and other liabilities
Net premium amortization/discount (accretion) on securities
Securities losses (gains), net
Amortization of core deposit
Stock based compensation
Net gain on sale of other real estate owned
Provision for other real estate owned losses
Net gain on disposal of fixed assets
Loss on transfer of premises to other real estate owned
Net cash provided by (used in) operating activities
Cash flows from investing activities
Proceeds from maturities and calls including pay down of securities available-for-sale
Proceeds from sales of securities available-for-sale
Purchases of securities available-for-sale
Proceeds from maturities and calls including pay down of securities held-to-maturity
Purchases of securities held-to-maturity
Proceeds from sales of Federal Home Loan Bank stock
Net change in loans
Improvements in other real estate owned
Proceeds from sales of other real estate owned
Proceeds from disposition of premises and equipment
Net purchases of premises and equipment
Net cash (used in) provided by investing activities
Cash flows from financing activities
Net change in deposits
Net change in securities sold under repurchase agreements
Net change in other short-term borrowings
Redemption of preferred stock
Proceeds from the issuance of common stock
Dividends paid on preferred stock
Purchase of treasury stock
Net cash provided by (used in) financing activities
Net change in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Year Ended
December 31,
2014
2013
2015
$
15,385 $
10,136 $
82,085
2,386
1,141
(4,400)
-
8,756
(190,041)
196,431
(5,775)
100
(1,221)
-
(3,949)
(2,668)
79
178
-
613
(1,073)
4,076
(20)
1,139
21,137
46,230
70,176
(196,082)
13,281
-
540
16,073
-
18,836
30
(1,280)
(32,196)
2,485
1,214
(3,300)
-
5,563
(122,996)
124,458
(3,594)
86
(1,397)
-
(581)
(20,001)
(1,824)
(1,719)
1,177
295
(989)
4,559
-
121
(6,307)
16,520
296,013
(325,020)
9,703
(11,212)
1,234
(74,338)
(794)
22,857
1
(1,097)
(66,133)
2,794
(260)
(8,550)
(612)
(70,376)
(181,497)
191,019
(5,627)
(132)
(1,603)
396
8,764
8,877
(528)
1,912
2,099
167
(1,956)
8,293
(9)
-
35,256
40,028
533,302
(609,033)
2,444
(21,382)
910
21,505
(73)
43,668
10
(1,798)
9,581
74,031
13,034
(30,000)
(47,331)
-
(2,417)
(117)
7,200
(3,859)
44,197
40,338 $
$
2,927
(1,524)
40,000
(24,321)
64,331
(12,390)
(46)
68,977
(3,463)
47,660
44,197 $
(35,091)
4,685
(95,000)
-
-
-
(278)
(125,684)
(80,847)
128,507
47,660
48
Year Ended
December 31,
2014
2013
2015
$
118 $
40 $
3,958
5,142
8,530
468
-
-
(544)
-
-
5,533
22,708
13,918
2,160
-
-
(9,112)
58
-
266
7,868
864
19,194
-
5,329
237,154
511
1,073
43
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows - Continued
(In thousands)
Supplemental cash flow information
Income taxes paid, net
Interest paid for deposits
Interest paid for borrowings
Non-cash transfer of loans to other real estate owned
Non-cash transfer of premises to other real estate owned
Non-cash transfer of loans to securities available-for-sale
Non-cash transfer of securities available-for-sale to securities held-to-maturity
Change in dividends accrued and declared but not paid
Accretion on preferred stock discount
Fair value difference on recapture of restricted stock
See accompanying notes to consolidated financial statements.
49
Old Second Bancorp, Inc. and Subsidiaries
Consolidated Statements of Changes in
Stockholders’ Equity
(In thousands)
Additional
Accumulated
Other
Total
Stockholders’
Equity
Common Preferred Paid-In
Capital
Stock
$ 18,729 $ 71,869 $
Retained
Earnings
66,189 $ 12,048 $
Stock
Comprehensive Treasury
Loss
Stock
(1,327) $ (94,956) $
82,085
(5,711)
101
(101)
(43)
167
(569)
(278)
$ 18,830 $ 72,942 $
66,212 $ 92,549 $
(7,038) $ (95,803) $
1,073
(1,584)
$ 18,830 $ 72,942 $
66,212 $ 92,549 $
(7,038) $ (95,803) $
10,136
(675)
10
(10)
29
295
(25,669)
15,525
48,806
58
1,348
(3,336)
(46)
$ 34,365 $ 47,331 $ 115,332 $ 100,697 $
(7,713) $ (95,849) $
$ 34,365 $ 47,331 $ 115,332 $ 100,697 $
(7,713) $ (95,849) $
15,385
(4,946)
62
(62)
35
613
(47,331)
(1,873)
(117)
$ 34,427 $
- $ 115,918 $ 114,209 $
(12,659) $ (95,966) $
72,552
82,085
(5,711)
-
(612)
167
(278)
(511)
147,692
147,692
10,136
(675)
-
29
295
(46)
(24,321)
64,331
(3,278)
194,163
194,163
15,385
(4,946)
-
35
613
(117)
(47,331)
(1,873)
155,929
Balance, December 31, 2012
Net Income
Other comprehensive loss, net of tax
Change in restricted stock
Recapture of restricted stock
Stock based compensation
Purchase of treasury stock
Preferred stock accretion and declared dividends
Balance, December 31, 2013
Balance, December 31, 2013
Net income
Other comprehensive loss, net of tax
Change in restricted stock
Tax effect from vesting of restricted stock
Stock based compensation
Purchase of treasury stock
Redemption of preferred stock
Common stock offering
Preferred stock accretion and declared dividends
Balance, December 31, 2014
Balance, December 31, 2014
Net income
Other comprehensive loss, net of tax
Change in restricted stock
Tax effect from vesting of restricted stock
Stock based compensation
Purchase of treasury stock
Redemption of preferred stock
Preferred stock dividends declared
Balance, December 31, 2015
See accompanying notes to consolidated financial statements.
50
Old Second Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2015, 2014 and 2013
(Table amounts in thousands, except per share data)
Note 1: Summary of Significant Accounting Policies
The Company uses the accrual basis of accounting for financial reporting purposes.
Use of Estimates – The preparation of consolidated financial statements in conformity with generally accepted accounting principles
(“GAAP”) and following general practices within the banking industry requires management to make estimates and assumptions that
affect the amounts reported in the consolidated financial statements and accompanying notes. Although these estimates and
assumptions are based on the best available information, actual results could differ from those estimates.
Principles of Consolidation – The accompanying consolidated financial statements include the accounts and results of operations of
the Company and its subsidiaries after elimination of all significant intercompany accounts and transactions. Assets held in a fiduciary
or agency capacity are not assets of the Company or its subsidiaries and are not included in the consolidated financial statements.
Cash and Cash Equivalents – For purposes of the Consolidated Statements of Cash Flows, management has defined cash and cash
equivalents to include cash and due from banks, interest-bearing deposits in other banks, and other short-term investments, such as
federal funds sold and securities purchased under agreements to resell.
Securities – Securities are classified as available-for-sale or held-to-maturity at the time of purchase or transfer.
Securities that are classified as available-for-sale are carried at fair value. Unrealized gains and losses, net of related deferred income
taxes, are recorded in stockholders’ equity as a separate component of accumulated other comprehensive income or loss.
Securities held-to-maturity are carried at amortized cost and the discount or premium created at acquisition or in the transfer from
available-for-sale is accreted or amortized to the maturity or expected payoff date but not an earlier call.
The historical cost of debt securities is adjusted for amortization of premiums and accretion of discounts over the estimated life of the
security, using the level yield method. Amortization of premium and accretion of discount are included in interest income from the
related security.
Purchases and sales of securities are recognized on a trade date basis. Realized securities gains or losses are reported in securities
gains, net in the Consolidated Statements of Income. The cost of securities sold is based on the specific identification method. On a
quarterly basis, the Company makes an assessment (at the individual security level) to determine whether there have been any events or
circumstances indicating that a security with an unrealized loss is other-than-temporarily impaired (“OTTI”). In evaluating OTTI, the
Company considers many factors, including the severity and duration of the impairment; the financial condition and near-term
prospects of the issuer, which for debt securities considers external credit ratings and recent downgrades; its ability and intent to hold
the security for a period of time sufficient for a recovery in value; and the likelihood that it will be required to sell the security before a
recovery in value, which may be at maturity. The amount of the impairment related to other factors is recognized in other
comprehensive income (loss) unless management intends to sell the security or believes it is more likely than not that it will be required
to sell the security prior to full recovery.
Federal Home Loan Bank and Federal Reserve Bank Stock – The Company owns the stock of the Federal Home Loan Bank of
Chicago (“FHLBC”) and the Federal Reserve Bank of Chicago (“Reserve Bank”). Both of these entities require the Bank to invest in
their nonmarketable stock as a condition of membership. The FHLBC is a governmental sponsored entity. The Bank continues to
utilize the various products and services of the FHLBC and management considers this stock to be a long-term investment. FHLBC
members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional
amounts. FHLBC stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on
ultimate recovery of par value. The Company’s ability to redeem the shares owned is dependent on the redemption practices of the
FHLBC. The Company records dividends in income on the ex-dividend date. Reserve Bank stock is redeemable at par, and therefore
market value equals cost.
Loans Held-for-Sale – The Bank originates residential mortgage loans, which consist of loan products eligible for sale to the
secondary market. Residential mortgage loans eligible for sale in the secondary market are carried at fair market value. The fair value
of loans held-for-sale is determined using quoted secondary market prices on similar loans.
51
Loans – Loans held-for-investment are carried at the principal amount outstanding, including certain net deferred loan origination fees
and costs. Interest income on loans is accrued based on principal amounts outstanding. Loan and lease origination fees, commitment
fees, and certain direct loan origination costs are deferred, and the net amount is amortized over the life of the related loans or
commitments as a yield adjustment. Fees related to standby letters of credit, whose ultimate exercise is remote, are amortized into fee
income over the estimated life of the commitment. Other credit-related fees are recognized as fee income when earned.
Concentration of Credit Risk – Most of the Company’s business activity is with customers located within Kane, Kendall, DeKalb,
DuPage, LaSalle, Will and Cook counties in Illinois. These banking centers surround the Chicago metropolitan area. Therefore, the
Company’s exposure to credit risk is significantly affected by changes in the economy in that market area since the Bank generally
makes loans within its market. There are no significant concentrations of loans where the customers’ ability to honor loan terms is
dependent upon a single economic sector.
Commercial and Industrial Loans – Such credits typically comprise working capital loans, loans for physical asset expansion, asset
acquisition loans and other business loans. Loans to closely held businesses will generally be guaranteed in full or for a meaningful
amount by the businesses’ major owners. Commercial loans are made based primarily on the historical and projected cash flow of the
borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not
behave as forecasted and collateral securing loans may fluctuate in value due to economic or individual performance factors. Minimum
standards and underwriting guidelines have been established for all commercial loan types.
Commercial Real Estate Loans – Commercial real estate loans are subject to underwriting standards and processes similar to
commercial and industrial loans. These are loans secured by mortgages on real estate collateral. Commercial real estate loans are
viewed primarily as cash flow loans and the repayment of these loans is largely dependent on the successful operation of the
property. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real
estate market such as geographic location and/or property type.
Residential Real Estate Loans – These are loans that are extended to purchase or refinance 1 – 4 family residential dwellings, or to
purchase or refinance vacant lots intended for the construction of a 1 – 4 family home. Residential real estate loans are considered
homogenous in nature. Homes may be the primary or secondary residence of the borrower or may be investment properties of the
borrower.
Real Estate Construction & Development Loans – The Company defines construction loans as loans where the loan proceeds are
controlled by the Company and used exclusively for the improvement of real estate in which the Company holds a mortgage. Due to
the inherent risk in this type of loan, they are subject to other industry specific policy guidelines outlined in the Company’s Credit Risk
Policy and are monitored closely.
Consumer Loans – Consumer loans include loans extended primarily for consumer and household purposes although they may
include very small business loans for the purchase of vehicles and equipment to a single-owner enterprise and could include business
purpose lines of credit if made under the terms of a small business product whose features and underwriting criteria are specified in
advance by the Loan Committee. These also include overdrafts and other items not captured by the definitions above.
Nonaccrual loans – Generally, commercial loans and loans secured by real estate are placed on nonaccrual status (i) when either
principal or interest payments become 90 days or more past due based on contractual terms unless the loan is sufficiently collateralized
such that full repayment of both principal and interest is expected and is in the process of collection within a reasonable period or
(ii) when an individual analysis of a borrower’s creditworthiness indicates a credit should be placed on nonaccrual status whether or not
the loan is 90 days or more past due. When a loan is placed on nonaccrual status, unpaid interest credited to income is reversed.
Generally, after the loan is placed on nonaccrual, all debt service payments are applied to the principal on the loan. Nonaccrual loans
are returned to accrual status when the financial position of the borrower and other relevant factors indicate there is no longer doubt that
the Company will collect all principal and interest due.
Commercial loans and loans secured by real estate are generally charged-off when deemed uncollectible. A loss is recorded at that time
if the net realizable value can be quantified and it is less than the associated principal outstanding.
Troubled Debt Restructurings (“TDRs”) – A restructuring of debt is considered a TDR when (i) the borrower is experiencing
financial difficulties and (ii) the creditor grants a concession, such as forgiveness of principal, reduction of the interest rate, changes in
payments, or extension of the maturity, that it would not otherwise consider. Loans are not classified as TDRs when the modification is
short-term or results in only an insignificant delay or shortfall in the payments to be received. The Company’s TDRs are determined on
a case-by-case basis in connection with ongoing loan collection processes.
The Company does not accrue interest on any TDRs unless it believes collection of all principal and interest under the modified terms
is reasonably assured. For TDRs to accrue interest, the borrower must demonstrate both some level of past performance and the
capacity to perform under the modified terms. Generally, six months of consecutive payment performance by the borrower under the
restructured terms is required before TDRs are returned to accrual status. However, the period could vary depending on the individual
facts and circumstances of the loan. An evaluation of the borrower’s current creditworthiness is used to assess whether the borrower
52
has the capacity to repay the loan under the modified terms. This evaluation includes an estimate of expected cash flows, evidence of
strong financial position, and estimates of the value of collateral, if applicable.
Impaired Loans – Impaired loans consist of nonaccrual loans and TDRs (both accruing and on nonaccrual). A loan is considered
impaired when it is probable that the Company will be unable to collect all contractual principal and interest due according to the terms
of the loan agreement based on current information and events. With the exception of TDRs still accruing interest, loans deemed to be
impaired are classified as nonaccrual and are exclusive of smaller homogeneous loans, such as home equity, 1-4 family mortgages, and
consumer loans.
90-Days or Greater Past Due Loans – 90-days or more past due loans are loans with principal or interest payments three months or
more past due, but that still accrue interest. The Company continues to accrue interest if it determines these loans are sufficiently
collateralized and the process of collection will conclude within a reasonable time period.
Allowance for Loan Losses – The allowance for loan losses is calculated according to GAAP standards and is maintained by
management at a level believed adequate to absorb estimated losses inherent in the existing loan portfolio. Determination of the
allowance for loan losses is inherently subjective since it requires significant estimates and management judgment, including the
amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on a
migration analysis that uses historical loss experience, consideration of current economic trends, and other credit market factors.
Loans deemed to be uncollectible are charged-off against the allowance for loan losses while recoveries of amounts previously
charged-off are credited to the allowance for loan losses. Approved releases from previously established loan loss reserves authorized
under our allowance methodology also reduce the allowance for loan losses. Additions to the allowance for loan losses are established
through the provision for loan losses charged to expense. The amount charged to operating expense depends on a number of factors,
including historic loan growth, changes in the composition of the loan portfolio, net charge-off levels, and the Company’s assessment
of the allowance for loan losses based on the methodology discussed below. The Company had no major methodology changes in
2014. One methodology change, implemented in 2015, reflects the use of average balances in historical required reserve calculations to
avoid loss rate impact if loan balances increase or decrease significantly. Previously, period end balances were used in the required
reserve calculation. A second methodology change negates quarterly net recovery data in the historical loss rate experience
calculations. The previous treatment of net recoveries was seen as a less meaningful treatment of current historical loss experience.
The last methodology change replaces the commercial real estate pool management factor with a collateral calculation on balances for
special mention and problem accruing loans in the period. This methodology change more accurately reflects all portfolio risk. The
result of these methodology changes increased the allowance for loan losses by approximately $1.3 million. All calculations conform
to U. S. generally accepted accounting principles.
The allowance for loan losses methodology consists of (i) specific reserves established for probable losses on individual loans for
which the recorded investment in the loan exceeds the present value of expected future cash flows or the net realizable value of the
underlying collateral, if collateral dependent, (ii) an allowance based on a loss migration analysis that uses historical credit loss
experience for each loan category, and (iii) the impact as assessed by management in detailed loan review sessions of other internal and
external qualitative and credit market factors.
The establishment of the allowance for loan losses involves a high degree of judgment and includes a level of imprecision given the
difficulty of identifying and assessing the factors impacting loan repayment and estimating the timing and amount of losses. While
management utilizes its best judgment and information available, the ultimate adequacy of the allowance for loan losses is dependent
upon a variety of factors beyond the Company’s direct control, including the performance of its loan portfolio, the economy, changes in
interest rates and property values, and the interpretation of loan risk classifications by regulatory authorities. While each component of
the allowance for loan losses is determined separately, the entire balance is available for the entire loan portfolio.
Mortgage Servicing Rights – The Bank is also involved in the business of servicing mortgage loans. Servicing activities include
collecting principal, interest, and escrow payments from borrowers, making tax and insurance payments on behalf of the borrowers,
monitoring delinquencies, executing foreclosure proceedings, and accounting for and remitting principal and interest payments to the
investors. Mortgage servicing rights represent the right to a stream of cash flows and an obligation to perform specified residential
mortgage servicing activities.
Mortgage loans that the Company is servicing for others aggregated to $638.2 million and $604.2 million at December 31, 2015, and
2014, respectively. Mortgage loans that the Company is servicing for others are not included in the consolidated balance sheets. Fees
received in connection with servicing loans for others are recognized as earned. Loan servicing costs are charged to expense as
incurred.
Servicing rights are recognized separately as assets when they are acquired through sales of loans and servicing rights are retained.
Servicing rights are initially recorded at fair value with the effect recorded in gains on sales of loans on the Consolidated Statements of
Income. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on
a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates
53
assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate,
the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses.
Servicing fee income, which is included on the Consolidated Statements of Income as mortgage servicing income, net of fair value
changes, is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or
a fixed amount per loan and are recorded as income when earned.
Under the fair value measurement method, the Company measures mortgage servicing rights at fair value at each reporting date, reports
changes in fair value of servicing assets in earnings in the period in which the changes occur, and includes these changes in mortgage
servicing gain, net of fair value changes, on the Consolidated Statements of Income. The fair values of mortgage servicing rights are
subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.
Other Real Estate Owned (“OREO”) – Real estate assets acquired in settlement of loans are recorded at fair value when acquired,
less estimated costs to sell, establishing a new cost basis. Any deficiency between the net book value and fair value at the foreclosure
or deed in lieu date is charged to the allowance for loan losses. If fair value declines after acquisition, a valuation allowance is
established for the decrease between the recorded value and the updated fair value less costs to sell. Such declines are included in other
noninterest expense. A subsequent reversal of an OREO valuation adjustment can occur, but the resultant carrying value cannot exceed
the cost basis established at transfer to OREO. OREO properties are valued at the lower of cost or fair value less estimated costs to
sell. Operating costs after acquisition are also expensed.
Premises and Equipment – Premises, furniture, equipment, and leasehold improvements are stated at cost less accumulated
depreciation and amortization. Depreciation expense is determined by the straight-line method over the estimated useful lives of the
assets. Leasehold improvements are amortized on a straight-line basis over the shorter of the life of the asset or the lease term
including anticipated renewals. Rates of depreciation are generally based on the following useful lives: buildings, 25 to 40 years;
building improvements, 3 to 15 years or longer under limited circumstances; and furniture and equipment, 3 to 10 years. Gains and
losses on dispositions are included in other noninterest income in the Consolidated Statements of Income. Maintenance and repairs are
charged to operating expenses as incurred, while improvements that conform to definitions of tangible property improvements are
capitalized and depreciated over the estimated remaining life.
Bank-Owned Life Insurance (“BOLI”) – BOLI represents life insurance policies on the lives of certain Company employees (both
current and former) for which the Company is the sole owner and beneficiary. These policies are recorded as an asset on the
Consolidated Statements of Financial Condition at their cash surrender value (“CSV”) or the amount that could be realized. The
change in CSV and insurance proceeds received are recorded as BOLI income in the Consolidated Statements of Income in noninterest
income.
Core Deposit Intangible – The core deposit intangible (“CDI”) was amortized on an accelerated method over its useful life and was
fully amortized in 2014.
Loss Contingencies – Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as
liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not
believe there are such matters that will have a material effect on the financial statements.
Wealth Management – Assets held in a fiduciary or agency capacity for customers are not included in the consolidated financial
statements as they are not assets of the Company or its subsidiaries. Fee income is included as a component of noninterest income in
the Consolidated Statements of Income.
Advertising Costs – All advertising costs incurred by the Company are expensed in the period in which they are incurred.
Long-term Incentive Plan – Compensation cost is recognized for stock options and restricted stock awards issued to employees based
upon the fair value of the awards at the date of grant. A binomial model is utilized to estimate the fair value of stock options, while the
market price of the Company’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized
over the required service period, generally defined as the vesting period. Once the award is settled, the Company would determine
whether the cumulative tax deduction exceeded the cumulative compensation cost recognized in the Consolidated Statement of Income.
The cumulative tax deduction would include both the deductions from the dividends and the deduction from the exercise or vesting of
the award. If the tax benefit received from the cumulative deductions exceeds the tax effect of the recognized cumulative
compensation cost, the excess would be recognized as an increase to additional paid-in capital.
Income Taxes – The Company files income tax returns in the U.S. federal jurisdiction and in Illinois. The provision for income taxes
is based on income in the consolidated financial statements, rather than amounts reported on the Company’s income tax return. Income
tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities.
54
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are
measured using the enacted tax rates that are expected to apply to taxable income in years in which those temporary differences are
expected to be recovered or settled. A full valuation allowance was previously established for the deferred tax assets excluding the
amount associated with a net unrealized gain or loss on available-for-sale investment securities. Due to the implicit recovery of the
book basis of the underlying securities along with management’s intent and ability to hold the securities to recovery or maturity, no
valuation allowance on this specific deferred tax asset was established. At September 30, 2013, the Company reversed a significant
portion of the valuation allowance after an analysis of both positive and negative evidence concerning the likelihood of deferred tax
asset recognition under GAAP. The remaining portion of the valuation allowance against the deferred tax assets was reversed in 2014.
See Note 11 – Income Taxes for further discussion.
As of December 31, 2015 and 2014, the Company evaluated tax positions taken for filing with the Internal Revenue Service and all state
jurisdictions in which it operates. The Company believes that income tax filing positions will be sustained under examination and does not
anticipate any adjustments that would result in a material adverse effect on the Company’s financial condition, results of operations, or
cash flows. Accordingly, the Company has not recorded any reserves or related accruals for interest and penalties for uncertain tax
positions at December 31, 2015 and 2014. The Company is currently open to audit under the statute of limitations by the Internal Revenue
Service from 2012 to 2014 and the appropriate state income taxing authorities from 2011 to 2014.
Earnings Per Common Share (“EPS”) – Basic EPS is computed by dividing net income applicable to common stockholders by the
weighted-average number of common shares outstanding for the period. Diluted EPS is computed by dividing net income applicable to
common shareholders by the weighted-average number of common shares outstanding plus the number of additional common shares that
would have been outstanding if the dilutive potential shares had been issued. The Company’s potential common shares represent shares
issuable under its long-term incentive compensation plans and under the common stock warrant issued to preferred stockholders. Such
common stock equivalents are computed based on the treasury stock method using the average market price for the period.
Treasury Stock – Treasury stock acquired is recorded at cost and is carried as a reduction of stockholders’ equity in the Consolidated
Balance Sheet. Treasury stock issued is valued based on the “last in, first out” inventory method. The difference between the
consideration received upon issuance and the carrying value is charged or credited to additional paid-in capital.
Mortgage Banking Derivatives – As part of ongoing residential mortgage business, the Company enters into mortgage banking
derivatives such as forward contracts and interest rate lock commitments. The derivatives and loans held-for-sale are carried at fair
value with the changes in fair value recorded in current earnings. The net gain or loss on mortgage banking derivatives is included in
gain on sale of loans.
Derivative Financial Instruments – The Company occasionally enters into derivative financial instruments as part of its interest rate
risk management strategies. These derivative financial instruments consist primarily of interest rate swaps.
The Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives
depends on the intended use of the derivative and whether the Company has elected to designate a derivative as a hedging relationship
and apply hedge accounting. A further consideration involves a determination on whether the hedging relationship has satisfied the
criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair
value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value
hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with
the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value
hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative
contracts that are intended to economically hedge certain risks, even though hedge accounting does not apply or the Company elects
not to apply hedge accounting.
If it is determined that the derivative instrument is not highly effective as a hedge, hedge accounting is discontinued, and the adjustment
to fair value of the derivative instrument is recorded in earnings. For a derivative used to hedge changes in cash flows associated with
forecasted transactions, the gain or loss on the effective portion of the derivative are deferred and reported as a component of
accumulated other comprehensive income, which is a component of shareholders’ equity, until such time the hedged transaction affects
earnings. For derivative instruments not accounted for as hedges, changes in fair value are recognized in noninterest income/expense.
Counterparty risk with correspondent banks is considered through loan covenant agreements and, as such, does not have a significant
impact on the fair value of the swaps. Deferred gains and losses from derivatives not accounted for as hedges and that are terminated
are amortized over the shorter of the original remaining term of the derivative or the remaining life of the underlying asset or liability.
Comprehensive Income – Comprehensive income is the total of reported earnings for all other revenues, expenses, gains, and losses that are
not reported in earnings under GAAP. The Company includes the following items, net of tax, in other comprehensive income in the
Consolidated Statements of Comprehensive Income: (i) changes in unrealized gains or losses on securities available-for-sale, (ii) changes in
unrealized gains or losses on securities held-to-maturity established upon transfer from securities available-for-sale and (iii) the effective
portion of a derivative used to hedge cash flows.
55
New Accounting Pronouncements: In May 2014, the FASB issued ASU No. 2014-09 "Revenue from Contracts with Customers
(Topic 606)." The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or
services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods
and services. ASU 2014-09 was to be effective for annual reporting periods beginning after December 15, 2016, including interim
periods within that reporting period. The Company is assessing the impact of ASU 2014-09 on its accounting and disclosures. In
August 2015, the FASB issued ASU 2015-14 “Revenue from Contracts with Customers (Topic 606) Deferral of the Effective Date.”
This accounting standards update defers the effective date for an additional year to be effective for annual reporting periods beginning
after December 15, 2017.
Note 2: Cash and Due from Banks
The Bank is required to maintain reserve balances with the Reserve Bank. In accordance with the Reserve Bank requirements, the
average reserve balances were $10.7 million and $16.0 million, for the years ended December 31, 2015, and 2014, respectively.
The nature of the Company’s business requires that it maintain amounts with other banks and federal funds which, at times, may
exceed federally insured limits. Management monitors these correspondent relationships, and the Company has not experienced any
losses in such accounts. In 2014, the Bank also had a $4.4 million pledge requirement, met with cash, to a correspondent bank as it
relates to credit card processing services and there was no such requirement in 2015.
Note 3: Securities
Investment Portfolio Management
Our investment portfolio serves the liquidity and income needs of the Company. While the portfolio serves as an important component
of the overall liquidity management at the Bank, portions of the portfolio will also serve as income producing assets. The size and
composition of the portfolio reflects liquidity needs, loan demand and interest income objectives.
Portfolio size and composition will be adjusted from time to time. While a significant portion of the portfolio consists of readily
marketable securities to address liquidity, other parts of the portfolio may reflect funds invested pending future loan demand or to
maximize interest income without undue interest rate risk.
Investments are comprised of debt securities and non-marketable equity investments. Until the third quarter of 2013, all debt securities
had been classified as available-for-sale. Securities available-for-sale are carried at fair value. Unrealized gains and losses, net of tax,
on securities available-for-sale are reported as a separate component of equity. This balance sheet component changes as interest rates
and market conditions change. Unrealized gains and losses are not included in the calculation of regulatory capital.
Securities held-to-maturity are carried at amortized cost and the discount or premium created in the 2013 transfer from available-for-
sale securities or at the time of purchase thereafter is accreted or amortized to the maturity or expected payoff date but not an earlier
call. In accordance with GAAP, the Company has the positive intent and ability to hold the securities to maturity.
Nonmarketable equity investments include FHLBC stock and Reserve Bank stock. FHLBC stock was $3.7 million and $4.3 million at
December 31, 2015, and December 31, 2014. Reserve Bank stock was $4.8 million at December 31, 2015, and December 31, 2014.
Our FHLBC stock is necessary to maintain access to FHLBC advances.
56
The following table summarizes the amortized cost and fair value of the securities portfolio at December 31, 2015 and
December 31, 2014 and the corresponding amounts of gross unrealized gains and losses (in thousands):
December 31, 2015:
Securities Available-for-Sale
U.S. Treasury
U.S. government agencies
U.S. government agencies mortgage-backed
States and political subdivisions
Corporate bonds
Collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Total Securities Available-for-Sale
Securities Held-to-Maturity
U.S. government agency mortgage-backed
Collateralized mortgage obligations
Total Securities Held-to-Maturity
December 31, 2014:
Securities Available-for-Sale
U.S. Treasury
U.S. government agencies
States and political subdivisions
Corporate bonds
Collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Total Securities Available-for-Sale
Securities Held-to-Maturity
U.S. government agency mortgage-backed
Collateralized mortgage obligations
Total Securities Held-to-Maturity
Gross
Gross
Amortized
Unrealized
Unrealized
Cost
Gains
Losses
Fair
Value
$
$
$
$
1,509 $
1,683
2,040
30,341
30,157
68,743
241,872
94,374
470,719 $
- $
-
-
285
-
24
74
-
383 $
- $
(127)
(44)
(100)
(757)
(1,847)
(10,038)
(2,123)
(15,036) $
1,509
1,556
1,996
30,526
29,400
66,920
231,908
92,251
456,066
36,505 $
211,241
247,746 $
1,592 $
3,302
4,894 $
- $
(965)
(965) $
38,097
213,578
251,675
Amortized
Cost
Gross
Gross
Unrealized
Unrealized
Gains
Losses
1,529 $
1,711
21,682
31,243
65,728
175,565
94,236
391,694 $
- $
-
432
309
31
199
176
1,147 $
(2) $
(87)
(96)
(567)
(2,132)
(2,268)
(2,203)
(7,355) $
Fair
Value
1,527
1,624
22,018
30,985
63,627
173,496
92,209
385,486
37,125 $
222,545
259,670 $
2,030 $
3,005
5,035 $
- $
(1,439)
(1,439) $
39,155
224,111
263,266
$
$
$
$
During the twelve months ended December 31, 2015, we added $58.7 million to the total securities portfolio (net of payoffs, maturities,
sales, calls, amortization and accretion). This change is largely found in asset-backed securities and, to a lesser amount, states and
political subdivisions. Holdings of asset backed securities, primarily securities backed by student loan obligations, were reduced in
2014.
Securities valued at $340.2 million as of December 31, 2015, (up from $267.8 million at year-end 2014) were pledged to secure
deposits and for other purposes.
57
The fair value, amortized cost and weighted average yield of debt securities at December 31, 2015, by contractual maturity, were as
follows in the table below. Securities not due at a single maturity date are shown separately.
Securities Available-for-Sale
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Mortgage-backed and collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Securities Held-to-Maturity
Mortgage-backed and collateralized mortgage obligations
Weighted
Amortized Average
Cost
Yield
Fair
Value
$
17,130
6,897
34,843
4,820
63,690
70,783
241,872
94,374
$ 470,719
1.74 %
2.92 %
2.39 %
3.21 %
2.33 %
2.29 %
1.47 %
3.06 %
2.03 %
$
17,138
6,959
34,171
4,723
62,991
68,916
231,908
92,251
$ 456,066
$ 247,746
2.78 %
$ 251,675
At December 31, 2015, the Company’s investments include asset-backed securities that are backed by student loans originated under
the Federal Family Education Loan program (“FFEL”). Under the FFEL, private lenders made federally guaranteed student loans to
parents and students. While the program was modified several times before elimination in 2010, not less than 97% of the outstanding
principal amount of the loans made under FFEL are guaranteed by the U.S. Department of Education. A number of major student loan
originators packaged loans and sold them as asset-backed securities.
The Company has accumulated the securities of the following three different originators that individually amount to over 10% of the
Company’s stockholders equity. Information regarding these three issuers and the value of the securities issued follows:
Issuer
College Loan Corporation
Nelnet Student Loan
GCO Education Loan Funding Corp
December 31, 2015
Fair
Value
Amortized
Cost
73,293
23,359
37,508
$
$
70,254
23,291
35,263
Securities with unrealized losses at December 31, 2015, and December 31, 2014, aggregated by investment category and length of time
that individual securities have been in a continuous unrealized loss position, were as follows (in thousands except for number of
securities):
December 31, 2015
Securities Available-for-Sale
U.S. government agencies
U.S. government agencies mortgage-backed
States and political subdivisions
Corporate bonds
Collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Securities Held-to-Maturity
Collateralized mortgage obligations
Less than 12 months
in an unrealized loss position
Fair
Value
Number of Unrealized
Securities Losses
- $
1
2
5
4
9
5
26 $
- $
44
19
292
334
2,080
446
-
1,996
1,541
14,866
16,218
78,301
29,480
3,215 $ 142,402
Greater than 12 months
in an unrealized loss position
Fair
Value
Number of Unrealized
Securities Losses
1 $
1,556
-
-
1
1,713
3
14,534
7
43,618
8
121,217
62,771
9
29 $ 11,821 $ 245,409
127 $
-
81
465
1,513
7,958
1,677
Total
127 $
Fair
Value
Number of Unrealized
Securities Losses
1 $
1,556
1
1,996
3
3,254
8
29,400
11
59,836
17
199,518
92,251
14
55 $ 15,036 $ 387,811
44
100
757
1,847
10,038
2,123
8 $
8 $
505 $ 40,307
505 $ 40,307
2 $
2 $
460 $ 33,842
460 $ 33,842
10 $
10 $
965 $ 74,149
965 $ 74,149
58
December 31, 2014
Securities Available-for-Sale
U.S. Treasury
U.S. government agencies
States and political subdivisions
Corporate bonds
Collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Securities Held-to-Maturity
Collateralized mortgage obligations
Less than 12 months
in an unrealized loss position
Fair
Number of Unrealized
Securities Losses
Greater than 12 months
in an unrealized loss position
Fair
Number of Unrealized
Value Securities Losses
Value Securities Losses
Number of Unrealized
1 $
-
4
4
5
9
12
35 $
2 $
-
96
486
900
1,077
2,203
1,527
-
4,896
15,246
38,284
99,286
82,387
4,764 $ 241,626
- $
1
-
1
3
3
-
8 $
- $
87
-
81
1,232
1,191
-
-
1,624
-
1,921
21,604
43,662
-
2,591 $ 68,811
1 $
1
4
5
8
12
12
43 $
Total
Fair
Value
1,527
1,624
4,896
17,167
59,888
142,948
82,387
7,355 $ 310,437
2 $
87
96
567
2,132
2,268
2,203
7 $
7 $
457 $ 49,302
457 $ 49,302
4 $
4 $
982 $ 46,283
982 $ 46,283
11 $
11 $
1,439 $ 95,585
1,439 $ 95,585
Recognition of other-than-temporary impairment was not necessary in the year ended December 31, 2015, or the year ended
December 31, 2014. The changes in fair value related primarily to interest rate fluctuations. Our review of other-than-temporary
impairment confirmed no credit quality deterioration.
Proceeds from sales of securities
Gross realized gains on securities
Gross realized losses on securities
Securities gains (losses), net
Income tax expense (benefit) on net realized gains (losses)
Note 4: Loans
Major classifications of loans were as follows:
$
$
$
2013
Years ended December 31,
2015
2014
70,176 $ 296,013 $ 533,302
5,376
(7,288)
(1,912)
(784)
3,231
(1,512)
1,719 $
704 $
106
(284)
(178) $
(71) $
Commercial
Real estate - commercial
Real estate - construction
Real estate - residential
Consumer
Overdraft
Lease financing receivables
Other
Net deferred loan costs
December 31, 2015 December 31, 2014
119,158
$
600,629
44,795
370,191
3,504
649
8,038
11,630
1,158,594
738
1,159,332
130,362 $
605,721
19,806
351,007
4,216
483
10,953
10,130
1,132,678
1,037
1,133,715 $
$
It is the policy of the Company to review each prospective credit in order to determine if an adequate level of security or collateral was
obtained prior to making a loan. The type of collateral, when required, will vary from liquid assets to real estate. The Company’s
access to collateral, in the event of borrower default, is assured through adherence to lending law, the Company’s lending standards and
credit monitoring procedures. The Bank generally makes loans solely within its market area. There are no significant concentrations of
loans where the customers’ ability to honor loan terms is dependent upon a single economic sector although the real estate related
categories listed above represent 86.1% and 87.6% of the portfolio at December 31, 2015, and December 31, 2014, respectively.
59
Aged analysis of past due loans by class of loans as of December 31, 2015, and December 31, 2014, were as follows:
.
December 31, 2015
Commercial
Real estate - commercial
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail properties
Farm
Real estate - construction
Homebuilder
Land
Commercial speculative
All other
Real estate - residential
Investor
Owner occupied
Revolving and junior liens
Consumer
All other1
December 31, 2014
Commercial
Real estate - commercial
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail properties
Farm
Real estate - construction
Homebuilder
Land
Commercial speculative
All other
Real estate - residential
Investor
Owner occupied
Revolving and junior liens
Consumer
All other1
90 Days or
30-59 Days 60-89 Days Greater Past Total Past
Past Due Past Due
$
Due
394
Due
-
-
$
$
$
394 $
Current
140,848 $
Recorded
Investment
90 days or
Greater Past
Due and
Nonaccrual Total Loans Accruing
-
141,315 $
73 $
652
358
-
-
-
-
-
-
-
6
101
1,083
344
4
-
2,942
$
$
119
-
-
-
-
-
-
-
-
77
-
446
68
-
-
710
$
-
-
-
-
-
-
-
-
-
65
-
-
-
-
-
65
771
358
-
-
-
-
-
-
-
148
101
1,529
412
4
-
123,479
170,827
166,668
92,387
34,352
12,615
2,604
1,137
2,117
13,717
125,611
110,885
102,500
4,212
11,650
1,254
763
975
-
-
1,272
-
-
83
-
125,504
171,948
167,643
92,387
34,352
13,887
2,604
1,137
2,200
13,865
972
6,378
2,619
-
-
126,684
118,792
105,531
4,216
11,650
$ 3,717 $ 1,115,609 $ 14,389 $ 1,133,715 $
-
-
-
-
-
-
-
-
-
65
-
-
-
-
-
65
30-59 Days 60-89 Days Greater Past Total Past
90 Days or
Past Due Past Due
$
38
-
$
$
Due
Due
Current
-
$
38 $
125,658 $
Recorded
Investment
90 days or
Greater Past
Due and
Nonaccrual Total Loans Accruing
-
127,196 $
1,500 $
699
-
-
-
-
-
-
-
-
71
-
1,076
94
-
-
1,978
$
$
-
-
-
-
-
-
-
-
-
29
-
914
44
-
-
987
$
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
699
-
-
-
-
-
-
-
-
100
-
1,990
138
-
-
126,029
167,874
153,328
87,054
37,780
14,157
3,204
1,658
13,431
25,841
135,273
107,727
113,906
3,504
13,017
5,937
1,441
4,907
1,423
-
-
-
-
-
561
132,665
169,315
158,235
88,477
37,780
14,157
3,204
1,658
13,431
26,502
1,942
6,711
2,504
-
-
137,215
116,428
116,548
3,504
13,017
$ 2,965 $ 1,129,441 $ 26,926 $ 1,159,332 $
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
1. The “All other” class includes overdrafts and net deferred loan fees and costs.
Credit Quality Indicators:
The Company categorizes loans into credit risk categories based on current financial information, overall debt service coverage,
comparison against industry averages, historical payment experience, and current economic trends. This analysis includes loans with
outstanding balances or commitments greater than $50,000 and excludes homogeneous loans such as home equity lines of credit and
residential mortgages. Loans with a classified risk rating are reviewed quarterly regardless of size or loan type. The Company uses the
following definitions for classified risk ratings:
Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention.
If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some
future date.
Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the
obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize
60
the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the
deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added
characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and
values, highly questionable and improbable.
Credits that are not covered by the definitions above are pass credits, which are not considered to be adversely rated. Loans listed as not
rated have outstanding loans or commitments less than $50,000 or are included in groups of homogeneous loans.
Credit Quality Indicators by class of loans as of December 31, 2015, and December 31, 2014, were as follows:
December 31, 2015
Commercial
Real estate - commercial
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail Properties
Farm
Real estate - construction
Homebuilder
Land
Commercial speculative
All other
Real estate - residential
Investor
Owner occupied
Revolving and junior liens
Consumer
All other
Total
December 31, 2014
Commercial
Real estate - commercial
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail Properties
Farm
Real estate - construction
Homebuilder
Land
Commercial speculative
All other
Real estate - residential
Investor
Owner occupied
Revolving and junior liens
Consumer
All other
Total
$
Pass
136,078
Special
Mention
$
3,208
Substandard 1
2,029
$
$
Doubtful
123,827
171,185
163,956
88,468
30,432
12,615
2,604
1,137
2,117
13,865
-
-
1,908
-
1,490
-
-
-
-
-
125,548
111,713
102,476
4,215
11,650
$ 1,101,886
$
-
-
-
-
-
6,606
$
1,677
763
1,779
3,919
2,430
1,272
-
-
83
-
1,136
7,079
3,055
1
-
25,223
$
Pass
118,845
Special
Mention
$
3,948
Substandard 1
4,403
$
124,936
154,225
148,212
78,957
36,779
14,157
3,204
1,658
9,947
25,941
253
11,607
3,235
8,097
1,001
-
-
-
-
-
134,952
109,085
112,647
3,503
13,017
$ 1,090,065
$
-
-
188
-
-
28,329
$
7,476
3,483
6,788
1,423
-
-
-
-
3,484
561
2,263
7,343
3,713
1
-
40,938
$
$
$
Doubtful
Total
141,315
$
125,504
171,948
167,643
92,387
34,352
13,887
2,604
1,137
2,200
13,865
126,684
118,792
105,531
4,216
11,650
1,133,715
Total
127,196
132,665
169,315
158,235
88,477
37,780
14,157
3,204
1,658
13,431
26,502
$
$
137,215
116,428
116,548
3,504
13,017
1,159,332
$
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
1 The substandard credit quality indicator includes both potential problem loans that are currently performing and nonperforming
loans
61
Impaired loans by class of loan as of December 31 were as follows:
Recorded
Investment
December 31, 2015
Unpaid
Principal
Balance
Related
Allowance
December 31, 2014
Unpaid
Principal
Balance
Related
Allowance
Recorded
Investment
With no related allowance recorded
Commercial
Commercial real estate
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail properties
Farm
Construction
Homebuilder
Land
Commercial speculative
All other
Residential
Investor
Owner occupied
Revolving and junior liens
Consumer
Total impaired loans with no recorded
allowance
With an allowance recorded
Commercial
Commercial real estate
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail properties
Farm
Construction
Homebuilder
Land
Commercial speculative
All other
Residential
Investor
Owner occupied
Revolving and junior liens
Consumer
Total impaired loans with a recorded
allowance
Total impaired loans
$
70 $
149 $
- $
1,500 $
2,114 $
2,314
763
1,047
-
-
1,272
-
-
83
-
1,906
10,539
2,731
-
3,004
871
1,065
-
-
1,338
-
-
86
-
2,259
11,999
3,947
-
20,725
24,718
3
-
-
-
-
-
-
-
-
-
-
8
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
3
-
-
-
-
-
-
-
-
-
-
-
112
46
-
-
112
46
-
-
31
-
-
7,125
1,798
4,831
1,423
-
-
1,791
-
-
291
2,595
11,419
2,238
-
7,870
1,941
5,653
1,930
-
-
1,791
-
-
323
3,024
12,816
3,541
-
35,011
41,003
-
-
-
76
-
-
-
-
-
-
270
135
23
371
-
-
-
-
76
-
-
-
-
-
-
306
145
65
405
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
21
-
-
-
-
-
-
98
24
38
97
-
161
20,886 $
166
24,884 $
$
34
34 $
875
35,886 $
997
42,000 $
278
278
62
Average recorded investment and interest income recognized on impaired loans by class of loan for the years ending December 31 were
as follows:
Year to date
December 31, 2015
Year to date
December 31, 2014
Year to date
December 31, 2013
Average
Recorded
Investment Recognized Investment Recognized Investment Recognized
Interest Average
Recorded
Income
Average
Recorded
Interest
Income
Interest
Income
With no related allowance recorded
Commercial
Commercial real estate
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail properties
Farm
Construction
Homebuilder
Land
Commercial speculative
All other
Residential
Investor
Owner occupied
Revolving and junior liens
Consumer
Total impaired loans with no recorded
allowance
With an allowance recorded
Commercial
Commercial real estate
Owner occupied general purpose
Owner occupied special purpose
Non-owner occupied general purpose
Non-owner occupied special purpose
Retail properties
Farm
Construction
Homebuilder
Land
Commercial speculative
All other
Residential
Investor
Owner occupied
Revolving and junior liens
Consumer
Total impaired loans with a recorded
allowance
Total impaired loans
$
785
$
- $
764
$
- $
112
$
4,720
1,280
2,939
712
-
636
895
-
42
145
2,251
10,979
2,484
-
82
-
3
-
-
-
-
-
-
-
51
160
7
-
4,834
2,584
5,130
1,042
1,572
-
1,903
105
369
147
4,290
10,299
2,004
-
104
45
-
-
-
-
82
-
-
-
43
187
6
-
3,508
5,275
9,892
569
5,962
1,259
3,085
232
1,501
41
5,576
9,284
1,570
11
27,868
303
35,043
467
47,877
2
-
-
38
-
-
-
-
-
-
135
67
68
208
-
-
-
-
-
-
-
-
-
-
-
-
-
-
3
-
-
365
2,150
508
-
-
-
84
-
587
353
410
794
934
-
-
-
-
-
-
-
-
-
-
-
-
-
1
-
-
283
872
4,277
1,859
-
876
-
97
-
2,748
458
2,713
3,737
1,981
-
-
3
-
75
-
-
-
97
-
-
-
-
209
6
-
390
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
518
28,386
$
$
3
306 $
6,185
41,228
$
1
468 $
19,901
67,778
$
-
390
Troubled debt restructurings (“TDRs”) are loans for which the contractual terms have been modified and both of these conditions exist:
(1) there is a concession to the borrower and (2) the borrower is experiencing financial difficulties. Loans are restructured on a case-
by-case basis during the loan collection process with modifications generally initiated at the request of the borrower. These
modifications may include reduction in interest rates, extension of term, deferrals of principal, and other modifications. The Bank
participates in the U.S. Department of the Treasury’s (the “Treasury”) Home Affordable Modification Program (“HAMP”) which gives
qualifying homeowners an opportunity to refinance into more affordable monthly payments.
The specific allocation of the allowance for loan losses on a TDR is determined by either discounting the modified cash flows at the
original effective rate of the loan before modification or is based on the underlying collateral value less costs to sell, if repayment of the
63
loan is collateral-dependent. If the resulting amount is less than the recorded book value, the Bank either establishes a valuation
allowance (i.e. specific reserve) as a component of the allowance for loan losses or charges off the impaired balance if it determines
that such amount is a confirmed loss. This method is used consistently for all segments of the portfolio.
Loans that were modified during the period are summarized as follows:
TDR Modifications
Twelve months ended December 31, 2015
# of
Post-modification
contracts recorded investment recorded investment
Pre-modification
Troubled debt restructurings
Real estate - residential
Owner occupied
Other1
Revolving and junior liens
HAMP3
Other1
Troubled debt restructurings
Real estate - commercial
Other1
Bifurcate2
Real estate - residential
Investor
Other1
Owner occupied
Other1
HAMP3
Deferral4
Revolving and junior liens
Other1
2 $
256 $
5
3
10 $
193
378
827 $
255
153
347
755
TDR Modifications
Twelve months ended December 31, 2014
# of
Post-modification
contracts recorded investment recorded investment
Pre-modification
2 $
1
1,320 $
675
2
1
2
2
237
136
250
344
5
15 $
343
3,305 $
1,106
357
221
133
218
224
334
2,593
1 Other: Change of terms from bankruptcy court
2 Bifurcate: Refers to an “A/B” restructure separated into two notes, charging off the entire B portion of the note.
3 HAMP: Home Affordable Modification Program
4 Deferral: Refers to the deferral of principal
64
TDRs are classified as being in default on a case-by-case basis when they fail to be in compliance with the modified terms. The
following table presents TDRs that defaulted during the periods shown and were restructured within the 12 month period prior to
default.
TDR Default Activity
TDR Default Activity
Troubled debt restructurings that
Subsequently Defaulted
Real estate - commercial
Owner occupied special purpose
Real estate - residential
Investor
Owner occupied
Revolving and junior liens
Twelve months ended December 31, 2015 Twelve months ended December 31, 2014
Pre-modification outstanding
contracts recorded investment contracts recorded investment
Pre-modification outstanding
# of
# of
- $
-
-
-
- $
-
-
-
-
-
- $
-
1
2
3 $
-
-
137
210
347
The Bank had no commitments to borrowers whose loans were classified as impaired at December 31, 2015.
Loans to principal officers, directors, and their affiliates, which are made in the ordinary course of business, were as follows at
December 31:
Beginning balance
New loans
Repayments and other reductions
Change in related party status
Ending balance
2015
7,793
864
(635)
(6,235)
1,787
$
$
2014
6,414
41,810
(38,295)
(2,136)
7,793
$
$
No loans to principal officers, directors, and their affiliates were past due greater than 90 days at either December 31, 2015, or
December 31, 2014.
Note 5: Allowance for Loan Losses
Changes in the allowance for loan losses by segment of loans based on method of impairment for the year ended December 31, 2015,
were as follows:
Allowance for loan losses:
Real Estate Real Estate
Real Estate
Commercial Commercial Construction Residential Consumer Unallocated Total
$
$
$
$
$
Beginning balance
Charge-offs
Recoveries
Provision (Release)
Ending balance
Ending balance: Individually evaluated for impairment
Ending balance: Collectively evaluated for impairment
Loans:
Ending balance
Ending balance: Individually evaluated for impairment
Ending balance: Collectively evaluated for impairment
1,475
2
276
(1,484)
265
-
265
$
$
$
1,981
1,639
1,075
277
1,694
31
1,663
19,806
83
19,723
$ 351,007
$
15,334
$ 335,673
$
1,454
483
359
(140)
$
1,190
$
2,506
-
-
(541)
$
1,965
21,637
4,770
3,756
(4,400)
16,223
-
1,190
$
$
-
1,965
$
$
34
16,189
4,216
-
4,216
$
$
$
11,650
-
11,650
$ 1,133,715
$
20,886
$ 1,112,829
$
$
$
$
$
$
$
$
$
$
$
$
1,644
993
451
994
2,096
3
2,093
$
$
$
12,577
1,653
1,595
(3,506)
9,013
-
9,013
$
$
$
$ 141,315
$
73
$ 141,242
$ 605,721
$
5,396
$ 600,325
65
Changes in the allowance for loan losses by segment of loans based on method of impairment for the year ended December 31, 2014,
were as follows:
Allowance for loan losses:
Real Estate Real Estate
Real Estate
Commercial Commercial Construction Residential Consumer Unallocated Total
$
$
$
$
$
$
$
Beginning balance
Charge-offs
Recoveries
(Release) provision
Ending balance
Ending balance: Individually evaluated for impairment
Ending balance: Collectively evaluated for impairment
2,250
578
58
(86)
1,644
-
1,644
$
$
$
Loans:
Ending balance
Ending balance: Individually evaluated for impairment
Ending balance: Collectively evaluated for impairment
$
$
$
127,196
1,500
125,696
Beginning balance
Charge-offs
Recoveries
(Release) provision
Ending balance
Ending balance: Individually evaluated for impairment
Ending balance: Collectively evaluated for impairment
4,517
316
119
(2,070)
2,250
-
2,250
$
$
$
Loans:
Ending balance
Ending balance: Individually evaluated for impairment
Ending balance: Collectively evaluated for impairment
$
$
$
104,805
27
104,778
16,763
1,972
1,346
(3,560)
12,577
21
12,556
600,629
15,253
585,376
20,100
2,985
5,325
(5,677)
16,763
1,152
15,611
560,233
21,116
539,117
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
1,980
174
633
(964)
1,475
98
1,377
$
$
$
2,837
3,393
1,842
695
1,981
159
1,822
44,795
2,352
42,443
$ 370,191
$
16,781
$ 353,410
3,837
1,014
1,266
(2,109)
1,980
355
1,625
$
$
$
4,535
6,293
1,221
3,374
2,837
888
1,949
29,351
4,746
24,605
$ 390,201
$
20,681
$ 369,520
1,439
526
420
121
1,454
-
1,454
3,504
-
3,504
1,178
597
508
350
1,439
-
1,439
2,760
-
2,760
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
2,012
-
-
494
2,506
-
2,506
$
$
$
27,281
6,643
4,299
(3,300)
21,637
278
21,359
13,017
-
13,017
$ 1,159,332
$
35,886
$ 1,123,446
4,430
-
-
(2,418)
$
2,012
38,597
11,205
8,439
(8,550)
27,281
-
2,012
$
$
2,395
24,886
13,906
-
13,906
$ 1,101,256
$
46,570
$ 1,054,686
Changes in the allowance for loan losses by segment of loans based on method of impairment for the year ended December 31, 2013,
were as follows:
Allowance for loan losses:
Real Estate Real Estate
Real Estate
Commercial Commercial Construction Residential Consumer Unallocated Total
$
$
$
$
$
$
$
The Company’s allowance for loan loss is calculated in accordance with GAAP and relevant supervisory guidance. All management
estimates were made in light of observable trends within loan portfolio segments, market conditions and established credit review
administration practices.
Note 6: Other Real Estate Owned
Details related to the activity in the other real estate owned (“OREO”) portfolio, net of valuation reserve, for the periods presented are
itemized in the following table.
Other real estate owned
Balance at beginning of period
Property additions
Property improvements
Less:
Property disposals, net of gains/losses
Period valuation adjustments
Balance at end of period
Twelve Months Ended
December 31,
2014
41,537
16,078
794
$
2013
$ 72,423
19,194
73
2015
$ 31,982
8,998
-
17,763
4,076
$ 19,141
21,868
4,559
31,982
41,712
8,441
$ 41,537
$
66
Activity in the valuation allowance was as follows:
Balance at beginning of period
Provision for unrealized losses
Reductions taken on sales
Other adjustments
Balance at end of period
Expenses related to OREO, net of lease revenue includes:
Gain on sales, net
Provision for unrealized losses
Operating expenses
Less:
Lease revenue
Note 7: Premises and Equipment
Premises and equipment at December 31 were as follows:
2015
$ 19,229
4,076
(9,271)
93
$ 14,127
2014
$ 22,284
4,559
(7,025)
(589)
$ 19,229
2013
$ 31,454
8,293
(17,389)
(74)
$ 22,284
$
2015
(1,073)
4,076
2,888
$
2014
(989)
4,559
4,173
$
2013
(1,956)
8,293
5,705
700
5,191
$
826
6,917
1,295
$ 10,747
$
2015
2014
Land
Buildings
Leasehold improvements
Furniture and equipment
Note 8: Deposits
Cost
16,318
42,627
74
41,411
100,430
$
$
Major classifications of deposits were as follows:
Noninterest bearing demand
Savings
NOW accounts
Money market accounts
Certificates of deposit of less than $100,000
Certificates of deposit of $100,000 through $250,000
Certificates of deposit of more than $250,000
$
Accumulated
Depreciation/ Net Book
Amortization Value
-
22,240
73
38,505
60,818
16,318 $
20,387
1
2,906
39,612 $
$
$
$
Cost
16,693
44,246
74
40,594
101,607
$
Accumulated
Depreciation/ Net Book
Amortization Value
-
21,540
73
37,659
59,272
16,693
22,706
1
2,935
42,335
$
$
$
2015
442,639 $
252,169
376,720
279,709
235,336
109,855
62,658
1,759,086 $
2014
400,447
239,845
328,641
296,617
251,108
112,515
55,882
1,685,055
$
$
The Company had $3.9 million in brokered certificates of deposit as of December 31, 2015. The Company had $255,000 in brokered
certificates of deposit as of December 31, 2014. Deposits held by senior officers and directors, including their related interests, totaled
$1.6 million and $15.1 million, respectively, as of December 31, 2015 and 2014.
At December 31, 2015, scheduled maturities of time deposits were as follows:
2016
2017
2018
2019
2020
Total
67
$
155,633
116,127
62,131
24,603
49,355
407,849
$
Note 9: Borrowings
The following table is a summary of borrowings as of December 31, 2015, and December 31, 2014. Junior subordinated debentures are
discussed in detail in Note 10:
Securities sold under repurchase agreements
FHLBC advances1
Junior subordinated debentures
Subordinated debt
Notes payable and other borrowings
2015
2014
$
$
34,070
15,000
58,378
45,000
500
152,948
$
$
21,036
45,000
58,378
45,000
500
169,914
1
Included in other short-term borrowing on the balance sheet.
The Company enters into deposit sweep transactions where the transaction amounts are secured by pledged securities. These
transactions consistently mature within 1 to 90 days from the transaction date and are governed by sweep repurchase agreements. All
sweep repurchase agreements are treated as financings secured by U.S. government agencies and collateralized mortgage-backed
securities and had a carrying amount of $34.1 million at December 31, 2015, and $21.0 million at December 31, 2014. The fair value of
the pledged collateral was $45.4 million and $43.4 million at December 31, 2015 and December 31, 2014, respectively. At
December 31, 2015, there were no customers with secured balances exceeding 10% of stockholders’ equity.
The following table is a summary of additional information related to repurchase agreements:
Average daily balance during the year
Average interest rate during the year
Maximum month-end balance during the year
Weighted average interest rate at year-end
2015
$ 28,194
2014
$ 26,093
2013
$ 23,313
0.01 %
0.01 %
0.01 %
$ 34,785
$ 38,133 $ 30,510
0.01 %
0.01 %
0.01 %
The Company’s borrowings at the FHLBC require the Bank to be a member and invest in the stock of the FHLBC. Total borrowings
are generally limited to the lower of 35% of total assets or 60% of the book value of certain mortgage loans. As of December 31, 2015,
the Bank had taken an advance of $15.0 million at 0.16% interest on the FHLBC stock valued at $3.7 million, collateralized securities
with a fair value of $98.8 million and loans with a principal balance of $169.7 million, which carry a combined collateral value of
$190.7 million. The Company has excess collateral of $174.4 million available to secure borrowings.
One of the Company’s most significant borrowing relationships continued to be the $45.5 million credit facility with a correspondent
bank. That credit is composed of $500,000 in senior term debt, and $45.0 million of subordinated debt. The subordinated debt and the
senior term debt mature on March 31, 2018. The interest rate on the senior debt resets quarterly and at the Company’s option, is based
on, the lender’s prime rate or three-month LIBOR plus 90 basis points. The interest rate on the subordinated debt resets quarterly, and
is equal to three-month LIBOR plus 150 basis points. The Company had $500,000 in principal outstanding in senior term debt and
$45.0 million in principal outstanding in subordinated debt at the end of both December 31, 2015, and December 31, 2014. The term
debt is secured by all of the outstanding capital stock of the Bank. The Company has made all required interest payments on the
outstanding principal balance on a timely basis.
The credit facility agreement contains usual and customary provisions regarding acceleration of the senior debt upon the occurrence of
an event of default by the Company under the senior debt agreement. The senior debt agreement also contains certain customary
representations and warranties, and financial covenants. At December 31, 2015, the Company was in compliance with all covenants
contained within the credit agreement supporting the $45.5 million credit facility with a correspondent bank. The agreement provides
that noncompliance is an event of default and as the result of the Company’s failure to comply with a financial covenant, the lender
may (i) terminate all commitments to extend further credit, (ii) increase the interest rate on the revolving line of the term debt by 200
basis points, (iii) declare the senior debt immediately due and payable and (iv) exercise all of its rights and remedies at law, in equity
and/or pursuant to any or all collateral documents, including foreclosing on the collateral. The total outstanding principal in senior debt
is the $500,000 in term debt. Because the subordinated debt is treated as Tier 2 capital for regulatory capital purposes, the senior debt
agreement does not provide the lender with any rights of acceleration or other remedies with regard to the subordinated debt upon an
event of default caused by the Company’s failure to comply with a financial covenant.
68
Scheduled maturities and weighted average rates of borrowings for the years ended December 31 were as follows:
2015
2016
2017
2018
2019
2020
Thereafter
Total
2015
Weighted
Average
2014
Weighted
Average
Balance Rate
Balance Rate
N/A
$ 49,070
-
45,500
-
-
58,378
$ 152,948
$ 66,036
N/A
-
0.06 %
-
-
45,500
1.82 %
-
-
-
-
7.35 %
58,378
3.37 % $ 169,914
0.09 %
-
-
1.75 %
-
-
7.35 %
3.03 %
Note 10: Junior Subordinated Debentures
The Company completed the sale of $27.5 million of cumulative trust preferred securities by its unconsolidated subsidiary, Old Second
Capital Trust I in June 2003. An additional $4.1 million of cumulative trust preferred securities were sold in July 2003. The costs
associated with the issuance of the cumulative trust preferred securities are being amortized over 30 years. The trust preferred
securities may remain outstanding for a 30-year term but, subject to regulatory approval, can be called in whole or in part by the
Company after June 30, 2008 and can be exercised by the Company from time to time thereafter. When not in deferral, distributions on
the securities are payable quarterly at an annual rate of 7.80%. The Company issued a new $32.6 million subordinated debenture to
Old Second Capital Trust I in return for the aggregate net proceeds of this trust preferred offering. The interest rate and payment
frequency on the debenture are equivalent to the cash distribution basis on the trust preferred securities.
The Company sold an additional $25.0 million of cumulative trust preferred securities through a private placement completed by an
additional, unconsolidated subsidiary, Old Second Capital Trust II, in April 2007. These trust preferred securities also mature in
30 years, but subject to the aforementioned regulatory approval, can be called in whole or in part on a quarterly basis commencing
June 15, 2017. The quarterly cash distributions on the securities are fixed at 6.77% through June 15, 2017 and float at 150 basis points
over three-month LIBOR thereafter. The Company issued a new $25.8 million subordinated debenture to the Old Second Capital
Trust II in return for the aggregate net proceeds of this trust preferred offering. The interest rate and payment frequency on the
debenture are equivalent to the cash distribution basis on the trust preferred securities.
Under the terms of the subordinated debentures issued to each of Old Second Capital Trust I and II, the Company is allowed to defer
payments of interest for 20 quarterly periods without default or penalty, but such amounts continue to accrue. Also during a deferral
period, the Company generally may not pay cash dividends on or repurchase its common stock or preferred stock, including the
Series B Fixed Rate Cumulative Perpetual Preferred Stock (the “Series B Stock”), as discussed in Note 20. In August of 2010, the
Company elected to defer regularly scheduled interest payments on the $58.4 million of junior subordinated debentures. Because of the
deferral on the subordinated debentures, the trusts deferred regularly scheduled dividends on the trust preferred securities. On April 21,
2014, the Company paid all outstanding interest, which totaled $19.7 million, on the trust preferred securities to the trustees for
payment to holders as of the next record date set forth in the indentures and terminated the deferral period. As of December 31, 2015
the Company is current on the payments due on these securities. Both of the debentures issued by the Company are disclosed on the
Consolidated Balance Sheet as junior subordinated debentures and the related interest expense for each issuance is included in the
Consolidated Statements of Income.
Note 11: Income Taxes
Income tax expense (benefit) for years ending December 31, 2015, 2014 and 2013 were as follows:
Current federal
Current state
Deferred federal
Deferred state
Change in valuation allowance
2015
2014
2013
220
-
7,023
1,733
-
8,976
$
$
105
122 $
29
6
2,780
3,120
989
4,876
(2,363)
(74,145)
5,761 $ (70,242)
$
$
69
The following were the components of the deferred tax assets and liabilities as of December 31, 2015 and December 31, 2014:
Allowance for loan losses
Deferred compensation
Amortization of core deposit
Goodwill amortization/impairment
Stock based compensation
OREO write-downs
Federal net operating loss (“NOL”) carryforward
State net operating loss (“NOL”) carryforward
Deferred tax credit
Other assets
Total deferred tax assets
Accumulated depreciation on premises and equipment
Mortgage servicing rights
State tax benefits
Other liabilities
Total deferred tax liabilities
Net deferred tax asset before adjustments related to other comprehensive loss
Tax effect of adjustments related to other comprehensive loss
Net deferred tax asset
2015
2014
7,099
690
1,629
11,623
814
6,917
24,105
8,746
1,749
792
64,164
(601)
(2,484)
(4,686)
(336)
(8,107)
56,057
8,495
64,552
$
$
9,579
787
1,859
13,129
663
8,639
27,001
9,405
1,551
1,006
73,619
(802)
(2,320)
(5,290)
(394)
(8,806)
64,813
5,328
70,141
$
$
At December 31, 2015, the Company had a $68.9 million federal net operating loss carryforward of which, $13.6 million expires in
2030, $31.4 million expires in 2031, $8.6 million expires in 2032, and $15.3 million expires in 2033. The Company had a
$112.9 million state net operating loss carryforward of which, $17.2 million expires in 2021, and $95.7 million expires in 2025. In
addition, the Company had a $1.7 million alternative minimum tax credit subject to indefinite carryforward. Included in the tax effect
of adjustments related to other comprehensive loss above are net unrealized losses on held-to-maturity securities that were transferred
from available-for-sale securities of $2.4 million and $2.8 million as of December 31, 2015 and December 31, 2014, respectively.
The components of the provision for deferred income tax expense (benefit) for the years ending December 31 were as follows:
Provision for loan losses
Deferred Compensation
Amortization of core deposit
Stock based compensation
OREO write-downs
Federal net operating loss carryforward
State net operating loss carryforward
Deferred tax credit
Depreciation
Net premiums and discounts on securities
Mortgage servicing rights
Goodwill amortization/impairment
State tax benefits
Change in valuation allowance
Other, net
Total deferred tax expense
2015
2014
2013
2,480 $
97
230
(151)
1,722
2,896
659
(198)
(201)
-
164
1,506
(604)
-
156
8,756 $
3,146 $
1
(203)
(80)
1,402
1,022
2,442
(107)
(233)
(8)
(251)
2,123
(1,704)
(2,363)
446
5,511
(109)
(691)
202
6,591
(7,287)
(1,661)
-
(28)
(114)
752
1,544
(321)
(74,145)
(620)
5,633 $ (70,376)
$
$
70
Effective tax rates differ from federal statutory rates applied to financial statement income (loss) for the years ended December 31 due
to the following:
Tax at statutory federal income tax rate
Nontaxable interest income, net of disallowed interest deduction
BOLI income
State income taxes, net of federal benefit
Change in valuation allowance
Deficiency from restricted stock
Impact of Illinois tax rate change
Other, net
Tax at effective tax rate
2015
2014
8,526
(253)
(487)
1,126
-
-
-
64
8,976
$
$
5,564
(233)
(508)
872
(2,363)
-
2,363
66
5,761
$
$
$
2013
4,145
(245)
(694)
662
(74,145)
10
-
25
$ (70,242)
The Company evaluated positive and negative evidence in order to determine if it was more likely than not that the deferred tax asset
would be recovered through future income. Significant positive evidence evaluated included recent and projected earnings,
significantly improved asset quality and an improved capital position. Negative evidence identified included a reduction in net interest
margin as a result of the current rate environment, and historic runoff of loans.
Note 12: Equity Compensation Plans
There are stock-based awards outstanding under the Company’s 2008 Equity Incentive Plan (the “2008 Plan”) and the Company’s 2014
Equity Incentive Plan (the “2014 Plan,” and together with the 2008 Plan, the “Plans”). The 2014 Plan was approved at the 2014 annual
meeting of stockholders. Following approval of the 2014 Plan, no further awards will be granted under the 2008 Plan or any other
Company equity compensation plan. A maximum of 375,000 shares may be issued under the 2014 Plan. The Plan authorizes the
granting of qualified stock options, non-qualified stock options, restricted stock, restricted stock units, and stock appreciation rights.
Awards may be granted to selected directors and officers or employees under the 2014 Plan at the discretion of the Compensation
Committee of the Company’s Board of Directors. As of December 31, 2015, 125,000 shares remained available for issuance under the
2014 Plan.
Total compensation cost that has been charged for the Plans was $613,000, $295,000 and $167,000 for the years ending
December 31, 2015, 2014 and 2013.
There were no stock options granted for the years ending December 31, 2015, 2014 or 2013. All stock options are granted for a term of
ten years. There were no stock options exercised during the years ending December 31, 2015 or 2014. There is no unrecognized
compensation cost related to unvested stock options as all stock options of the Company’s common stock have vested.
A summary of stock option activity in the Plans for the year ending December 31, 2015, is as follows:
Weighted-
Weighted Average
Average
Exercise Contractual Aggregate
Remaining
Shares Price
Term (years) Intrinsic Value
Beginning outstanding
Canceled
Expired
Ending outstanding
229,000 $
(36,500)
(30,000)
162,500 $
28.28
31.34
31.34
27.03
1.6 $
Exercisable at end of period
162,500 $
27.03
1.6 $
-
-
Generally, restricted stock and restricted stock units granted under the Plans vest three years from the grant date, but the Compensation
Committee of the Company’s Board of Directors has discretionary authority to change some terms including the amount of time until
the vest date.
Awards under the 2008 Plan will become fully vested upon a merger or change in control of the Company. Under the 2014 Plan, upon
a change in control of the Company, if (i) the 2014 Plan is not an obligation of the successor entity following the change in control, or
(ii) the 2014 Plan is an obligation of the successor entity following the change in control and the participant incurs an involuntary
termination, then the stock options, stock appreciation rights, stock awards and cash incentive awards under the 2014 Plan will become
fully exercisable and vested. Performance-based awards generally will vest based upon the level of achievement of the applicable
performance measures through the change in control.
71
The Company granted restricted stock under its equity compensation plans beginning in 2005 and it began granting restricted stock
units in February 2009. Restricted stock awards under the Plans generally entitle holders to voting and dividend rights upon grant and
are subject to forfeiture until certain restrictions have lapsed including employment for a specific period. Restricted stock units under
the Plans are also subject to forfeiture until certain restrictions have lapsed including employment for a specific period, and generally
entitle holders to receive dividend equivalents during the restricted period but do not entitle holders to voting rights until the restricted
period ends and shares are transferred in connection with the units.
There were 101,500 restricted awards issued during the year ending December 31, 2015. There were 184,500 restricted awards issued
for the year ending December 31, 2014. Compensation expense is recognized over the vesting period of the restricted award based on
the market value of the award on the issue date.
A summary of changes in the Company’s unvested restricted awards for the year ending December 31, 2015, is as follows:
December 31, 2015
Nonvested at January 1
Granted
Vested
Forfeited
Nonvested at December 31
Restricted
Stock Shares
and Units
325,000
101,500
(62,500)
(16,000)
348,000
Weighted
Average
Grant Date
Fair Value
4.15
5.38
4.13
4.43
4.50
$
$
Total unrecognized compensation cost of restricted awards was $733,000 as of December 31, 2015, which is expected to be recognized
over a weighted-average period of 1.92 years.
Note 13: Earnings Per Share
The earnings per share – both basic and diluted – are included below as of December 31 (in thousands except for share data):
2015
2014
2013
Basic earnings per share:
Weighted-average common shares outstanding
Weighted-average common shares less stock based awards
Weighted-average common shares stock based awards
Net income
Gain on preferred stock redemption
Preferred stock dividends and accretion, net of dividends waived
Net earnings available to common stockholders
Basic earnings per share common undistributed earnings
Basic earnings per share
Diluted earnings per share:
Weighted-average common shares outstanding
Dilutive effect of nonvested restricted awards1
Diluted average common shares outstanding
Net earnings available to common stockholders
Diluted earnings per share
$
29,476,821
29,476,821
-
15,385 $
-
1,873
13,512
N/A
0.46
25,300,909 13,939,919
25,298,813 13,896,893
209,140
82,085
-
5,258
76,827
5.45
5.45
201,558
10,136 $
(1,348)
(371)
11,855
0.46
0.46
29,476,821
253,253
29,730,074
$
$
13,512 $
0.46 $
248,284
25,300,909 13,939,919
166,114
25,549,193 14,106,033
76,827
5.45
11,855 $
0.46 $
Number of antidilutive options and warrants excluded from the diluted earnings per
share calculation
977,839
1,044,339
1,140,839
1 Includes the common stock equivalents for restricted share rights that are dilutive.
The above earnings per share calculation did not include a warrant for 815,339 shares of common stock that was outstanding as of
December 31, 2015, 2014 and 2013, because the warrant was anti-dilutive at an exercise price of $13.43. Of note, the warrant was sold
at auction by the Treasury in June 2013 to a third party investor.
72
Note 14: Commitments
In the normal course of business, there are outstanding commitments that are not reflected in the Consolidated Financial Statements.
Commitments include financial instruments that involve, to varying degrees, elements of credit, interest rate, and liquidity risk. In
management’s opinion, these do not represent unusual risks and management does not anticipate significant losses as a result of these
transactions. The Company uses the same credit policies in making commitments and conditional obligations for borrowers as it does
for on-balance sheet instruments.
The following table is a summary of financial instrument commitments (in thousands):
Letters of credit:
Borrower:
Financial standby
Commercial standby
Performance standby
Non-borrower:
Performance standby
Total letters of credit
December 31, 2015
Fixed
Variable Total
Fixed
December 31, 2014
Variable Total
$
$
60
-
66
126
-
-
126
$
3,572
47
7,350
10,969
$
3,632
47
7,416
11,095
$
575
575
11,544
575
575
11,670
$
$
$
55
-
416
471
-
-
471
$
4,745
49
5,690
10,484
$
4,800
49
6,106
10,955
572
572
11,056
$
572
572
11,527
$
Unused loan commitments:
$
71,016
$ 197,909
$ 268,925
$ 62,391
$ 169,717
$ 232,108
The Bank occupies facilities under long-term operating leases, some of which include provisions for future rent increases. In addition,
the Company leases space at sites that house automatic teller machines (ATMs). As of December 31, 2015, the estimated aggregate
minimum annual rental commitments under these leases totaled $50,000 in 2016, $33,000 in 2017, $24,000 in 2018, and $15,000
thereafter. The Company also receives rental income on certain leased properties. As of December 31, 2015, aggregate future
minimum rental income to be received under noncancelable leases totaled $113,000. Total facility net operating lease expense or
revenue recorded under all operating leases was a net expense of $11,000 in 2015 net revenue of $67,000 in 2014 and $64,000 in 2013.
Total ATM lease expense, including the costs related to servicing those ATM’s, was $826,000, $829,000 and $830,000 in 2015, 2014
and 2013, respectively.
Legal proceedings
The Company and its subsidiaries, from time to time, pursue collection suits and other actions that arise in the ordinary course of
business against their borrowers and are defendants in legal actions arising from normal business activities. Management, after
consultation with legal counsel, believes that the ultimate liabilities, if any, resulting from these actions will not have a material adverse
effect on the financial position of the Bank or on the consolidated financial position of the Company based on all known information at
this time.
Note 15: Regulatory & Capital Matters
The Bank is subject to the risk-based capital regulatory guidelines, which include the methodology for calculating the risk-weighted
Bank assets, developed by the Office of the Comptroller of the Currency (the “OCC”) and the other bank regulatory agencies. In
connection with the current economic environment, the Bank’s current level of nonperforming assets and the risk-based capital
guidelines, the Bank’s board of directors has determined that the Bank should maintain a Tier 1 leverage capital ratio at or above eight
percent (8%) and a total risk-based capital ratio at or above twelve percent (12%). The Bank currently exceeds those thresholds.
Bank holding companies are required to maintain minimum levels of capital in accordance with capital guidelines implemented by the
Board of Governors of the Federal Reserve System. The general bank and holding company capital adequacy guidelines in force as of
the periods reported are shown in the accompanying table, as are the capital ratios of the Company and the Bank, as of
December 31, 2015, and December 31, 2014.
In July 2013, the U.S. federal banking authorities issued final rules (the “Basel III Rules”) establishing more stringent regulatory capital
requirements for U.S. banking institutions, which went into effect on January 1, 2015. A detailed discussion of the Basel III Rules is
included in Part I, Item 1 of the under the heading “Supervision and Regulation.”
73
At December 31, 2015, the Company, on a consolidated basis, exceeded the minimum thresholds to be considered “adequately
capitalized” under current regulatory defined capital ratios. For all periods prior to 2015, all capital ratios displayed were calculated
without giving effect to the final Basel III capital rules.
The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies. The capital ratios
below are calculated pursuant to the capital requirements in effect for the periods reported below.
Capital levels and industry defined regulatory minimum required levels:
2015
Common equity tier 1 capital to risk weighted assets
Consolidated
Old Second Bank
Total capital to risk weighted assets
Consolidated
Old Second Bank
Tier 1 capital to risk weighted assets
Consolidated
Old Second Bank
Tier 1 capital to average assets
Consolidated
Old Second Bank
2014
Total capital to risk weighted assets
Consolidated
Old Second Bank
Tier 1 capital to risk weighted assets
Consolidated
Old Second Bank
Tier 1 capital to average assets
Consolidated
Old Second Bank
Actual
Amount Ratio
Minimum Required
for Capital
Adequacy Purposes
Amount Ratio
Minimum Required
to be Well
Capitalized 1
Amount Ratio
$ 151,410
202,158
10.55 % $
14.10
64,582
64,519
4.50 %
4.50
$
N/A
93,193
N/A
6.50 %
223,311
218,375
15.56
15.23
114,813
114,708
8.00
8.00
N/A
143,385
N/A
10.00
176,625
202,158
12.30
14.10
86,159
86,025
6.00
6.00
N/A
114,700
N/A
8.00
176,625
202,158
8.69
9.94
81,300
81,351
4.00
4.00
N/A
101,689
N/A
5.00
$ 240,566
254,897
17.68 %
18.73
$ 108,853
108,872
8.00 %
8.00
N/A
$ 136,090
N/A
10.00 %
196,499
237,828
14.44
17.47
54,432
54,454
4.00
4.00
N/A
81,681
N/A
6.00
196,499
237,828
9.93
12.02
79,154
79,144
4.00
4.00
N/A
98,930
N/A
5.00
1 The Bank exceeded the general minimum regulatory requirements to be considered “well capitalized”.
Dividend Restrictions and Deferrals
In addition to the above requirements, banking regulations and capital guidelines generally limit the amount of dividends that may be
paid by a Bank without prior regulatory approval. Under these regulations, the amount of dividends that may be paid in any calendar
year is limited to the current year’s profits, combined with the retained profit of the previous two years, subject to the capital
requirements described above. Pursuant to the Basel III rules that came into effect January 1, 2015, the Bank must keep a buffer of
0.625% in 2016, 1.25% in 2017, 1.875% in 2018, and 2.5% in 2019 and thereafter of minimum capital requirements in order to avoid
additional limitations on capital distributions. The Bank has the ability and the authority to pay dividends to the Company.
74
Note 16: Mortgage Banking Derivatives
Commitments to fund certain mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for
the future delivery of mortgage loans to third party investors are considered derivatives. It is the Company’s practice to sell mortgage-
backed securities (“MBS”) contracts for the future delivery to economically hedge the effect of changes in interest rates resulting from
its commitments to fund the loans. These contracts are also derivatives and collectively with the forward commitments for the future
delivery of mortgage loans are considered forward contracts. These mortgage banking derivatives are not designated in hedge
relationships using the accepted accounting for derivative instruments and hedging activities at December 31 (dollars in thousands):
Forward contracts:
Notional amount
Fair value
Change in fair value
Rate lock commitments:
Notional amount
Fair value
Change in fair value
2015
2014
$
$
15,500
484
21
10,973
502
167
$
$
14,000
615
(79)
10,876
509
222
Fair values were estimated based on changes in mortgage interest rates from the date of the commitments. Changes in the fair values of
these mortgage banking derivatives are included in net gains on sales of loans. The Company sold $190.6 million in loans to investors
receiving proceeds of $196.4 million and resulting in a gain on sale of $5.8 million for the year ended December 31, 2015. Sales to
investors included $132.7 million or 69.8% to Federal National Mortgage Association and $33.6 million, or 17.7% to Wells Fargo for
the year ended December 31, 2015. No other individual investor was sold more than 10% of the total loans sold.
Periodic changes in value of both forward MBS contracts and rate lock commitments are reported in current period earnings as net gain
on sale of mortgage loans. Net gain recognized in earnings for the years ended December 31, 2015, 2014 and 2013 were $188,000,
$143,000 and $315,000, respectively.
Note 17: Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the
principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the
measurement date. The fair value hierarchy established by the Company also requires an entity to maximize the use of observable
inputs and minimize the use of unobservable inputs when measuring fair value. Three levels of inputs that may be used to measure fair
value are:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the Company has the ability to
access as of the measurement date.
Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted
prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company’s own view about the assumptions that market participants
would use in pricing an asset or liability.
Transfers between levels are deemed to have occurred at the end of the reporting period. For the year ended December 31, 2015, the
Company transferred auction rate asset-backed securities from Level 3 to Level 2. For the year ended December 31, 2014 there were
no significant transfers between levels.
The majority of securities (available-for-sale and held-to-maturity) are valued by external pricing services or dealer market participants
and are classified in Level 2 of the fair value hierarchy. Both market and income valuation approaches are utilized. Quarterly, the
Company evaluates the methodologies used by the external pricing services or dealer market participants to develop the fair values to
determine whether the results of the valuations are representative of an exit price in the Company’s principal markets and an
appropriate representation of fair value. The Company uses the following methods and significant assumptions to estimate fair value:
Government-sponsored agency debt securities are primarily priced using available market information through processes such
as benchmark spreads, market valuations of like securities, like securities groupings and matrix pricing.
Other government-sponsored agency securities, MBS and some of the actively traded real estate mortgage investment conduits
and collateralized mortgage obligations are priced using available market information including benchmark yields,
prepayment speeds, spreads, volatility of similar securities and trade date.
75
State and political subdivisions are largely grouped by characteristics (e.g.., geographical data and source of revenue in trade
dissemination systems). Because some securities are not traded daily and due to other grouping limitations, active market
quotes are often obtained using benchmarking for like securities.
From December 31, 2013, to December 31, 2014, the Company utilized pricing data from a nationally recognized valuation
firm providing specialized securities valuation services for auction rate asset-backed securities. Beginning March 31, 2015,
these securities are priced using market spreads, cash flows, prepayment speeds, and loss analytics. Therefore, the valuations
of auction rate asset-backed securities were transferred to Level 2 valuations.
During the third quarter of 2014, asset-backed collateralized loan obligations were acquired and priced using data from a
pricing matrix supported by our bond accounting service provider and are therefore considered Level 2 valuations.
Once each quarter every security holding is priced by a pricing service independent of the regular and recurring pricing
services used. The independent service provides a measurement to indicate if the price assigned by the regular service is
within or outside of a reasonable range. Management reviews this report and applies judgment in adjusting calculations at
quarter end related to securities pricing.
Residential mortgage loans eligible for sale in the secondary market are carried at fair market value. The fair value of loans
held-for-sale is determined using quoted secondary market prices.
Lending related commitments to fund certain residential mortgage loans, e.g. residential mortgage loans with locked interest
rates to be sold in the secondary market and forward commitments for the future delivery of mortgage loans to third party
investors as well as forward commitments for future delivery of MBS are considered derivatives. Fair values are estimated
based on observable changes in mortgage interest rates including prices for MBS from the date of the commitment and do not
typically involve significant judgments by management.
The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net
servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net
servicing income to derive the resultant value. The Company is able to compare the valuation model inputs, such as the
discount rate, prepayment speeds, weighted average delinquency and foreclosure/bankruptcy rates to widely available
published industry data for reasonableness.
Interest rate swap positions, both assets and liabilities, are based on valuation pricing models using an income approach
reflecting readily observable market parameters such as interest rate yield curves.
The fair value of impaired loans with specific allocations of the allowance for loan losses is essentially based on recent real
estate appraisals or the fair value of the collateralized asset. These appraisals may utilize a single valuation approach or a
combination of approaches including comparable sales and the income approach. Adjustments are made in the appraisal
process by the appraisers to reflect differences between the available comparable sales and income data. Such adjustments are
usually significant and typically result in a Level 3 classification of the inputs for determining fair value.
Nonrecurring adjustments to certain commercial and residential real estate properties classified as OREO are measured at the
lower of carrying amount or fair value, less costs to sell. Fair values are based on third party appraisals of the property,
resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an
impairment loss is recognized.
76
Assets and Liabilities Measured at Fair Value on a Recurring Basis:
The tables below present the balance of assets and liabilities (dollars in thousands) at December 31, 2015, and December 31, 2014,
respectively, measured by the Company at fair value on a recurring basis:
Assets:
Investment securities available-for-sale
U.S. Treasury
U.S. government agencies
U.S. government agencies mortgage-backed
States and political subdivisions
Corporate Bonds
Collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Loans held-for-sale
Mortgage servicing rights
Other assets (Interest rate swap agreements)
Other assets (Mortgage banking derivatives)
Total
Liabilities:
Other liabilities (Interest rate swap agreements)
Total
Assets:
Investment securities available-for-sale
U.S. Treasury
U.S. government agencies
States and political subdivisions
Corporate bonds
Collateralized mortgage obligations
Asset-backed securities
Collateralized loan obligations
Loans held-for-sale
Mortgage servicing rights
Other assets (Interest rate swap agreements net of swap credit valuation)
Other assets (Mortgage banking derivatives)
Total
Liabilities:
Other liabilities (Interest rate swap agreements)
Total
Level 1
December 31, 2015
Level 3
Level 2
Total
$
1,509 $
-
-
-
-
-
-
-
-
-
-
-
- $
1,556
1,996
30,415
29,400
66,920
231,908
92,251
2,849
-
114
188
$
1,509 $ 457,597 $
- $
-
-
111
-
-
-
-
-
5,847
-
-
1,509
1,556
1,996
30,526
29,400
66,920
231,908
92,251
2,849
5,847
114
188
5,958 $ 465,064
$
$
- $
- $
745 $
745 $
- $
- $
745
745
Level 1
December 31, 2014
Level 3
Level 2
Total
$
1,527 $
-
-
-
-
-
-
-
-
-
-
- $
1,624
21,900
30,985
63,627
120,555
92,209
5,072
-
30
143
$
1,527 $ 336,145 $
- $
-
118
-
-
52,941
-
-
5,462
-
-
1,527
1,624
22,018
30,985
63,627
173,496
92,209
5,072
5,462
30
143
58,521 $ 396,193
$
$
- $
- $
30 $
30 $
- $
- $
30
30
77
The changes in Level 3 assets and liabilities (dollars in thousands) measured at fair value on a recurring basis are as follows:
Year ended December 31, 2015
Investment securities
available-for-sale
Beginning balance January 1, 2015
Transfers out of Level 3
Total gains or losses
Included in earnings (or changes in net assets)
Included in other comprehensive income
Purchases, issuances, sales, and settlements
Issuances
Settlements
Sales
Ending balance December 31, 2015
Beginning balance January 1, 2014
Total gains or losses
Included in earnings (or changes in net assets)
Included in other comprehensive income
Purchases, issuances, sales, and settlements
Purchases
Issuances
Settlements
Sales
Asset-
backed
52,941
(24,917)
States and
Political
Mortgage
Servicing
Subdivisions Rights
118
-
5,462
-
$
$
(28)
(541)
-
-
(27,455)
-
$
-
-
-
(7)
-
111
$
(466)
-
1,526
(675)
-
5,847
$
$
Investment securities available-for-sale
Year ended December 31, 2014
Asset-
backed
States and
Political
Subdivisions
Mortgage Interest Rate
Servicing
Rights Valuation
Swap
$
154,137
$
125 $
5,807 $
(6)
3,556
(1,454)
63,704
-
-
(167,002)
52,941
$
-
-
(1,214)
-
-
-
(7)
-
-
869
-
-
118 $ 5,462
$
6
-
-
-
-
-
-
Ending balance December 31, 2014
$
The following table and commentary presents quantitative (dollars in thousands) and qualitative information about Level 3 fair value
measurements as of December 31, 2015:
Measured at fair value
on a recurring basis:
Fair Value
Valuation Methodology
Mortgage Servicing rights
$
5,847
Discounted Cash Flow
Unobservable
Inputs
Range of Input
Weighted
Average
of Inputs
Discount Rate
Prepayment Speed
10.0-15.5%
6.0-35.2%
10.2 %
10.1 %
The following table and commentary presents quantitative (dollars in thousands) and qualitative information about Level 3 fair value
measurements as of December 31, 2014:
Measured at fair value
on a recurring basis:
Fair Value
Valuation Methodology
Mortgage Servicing rights
$
5,462
Discounted Cash Flow
Unobservable
Inputs
Range of Input
Discount Rate
Prepayment Speed
9.7-108.2%
5.0-78.4%
Asset-backed securities
52,941
Discounted Cash Flow
with comparable transaction yields
Credit Risk Premium
Liquidity Discount
0.9-0.9%
3.5-3.7%
Weighted
Average
of Inputs
10.2 %
10.9 %
0.9 %
3.6 %
The $111,000 on the state and political subdivisions line at December 31, 2015, under Level 3 represents a security from a small, local
municipality. Given the small dollar amount and size of the municipality involved, this is categorized as Level 3 based on the payment
stream received by the Company from the municipality. That payment stream is otherwise an unobservable input.
78
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis:
The Company may be required, from time to time, to measure certain other assets at fair value on a nonrecurring basis in accordance
with GAAP. These assets consist of impaired loans and OREO. For assets measured at fair value on a nonrecurring basis at
December 31, 2015, and December 31, 2014, respectively, the following tables provide the level of valuation assumptions used to
determine each valuation and the carrying value of the related assets:
Impaired loans1
Other real estate owned, net2
Total
Level 1
December 31, 2015
Level 3
Level 2
Total
$
$
-
-
-
$
$
-
-
-
$
81
19,141
$ 19,222
$
81
19,141
$ 19,222
1 Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of
collateral for collateral-dependent loans, had a carrying amount of $115,000, with a valuation allowance of $34,000, resulting in a
decrease of specific allocations within the allowance for loan losses of $243,000 for the year ending December 31, 2015.
2 OREO is measured at the lower of carrying or fair value less costs to sell, and had a net carrying amount of $19.1 million, which is
made up of the outstanding balance of $34.9 million, net of a valuation allowance of $14.1 million and participations of
$1.7 million, at December 31, 2015.
December 31, 2014
Impaired loans1
Other real estate owned, net2
Total
$
Level 1 Level 2 Level 3 Total
-
-
-
564
31,982
$ 32,546
564
31,982
$ 32,546
-
-
-
$
$
$
$
$
1 Represents carrying value and related write-downs of loans for which adjustments are substantially based on the appraised value of
collateral for collateral-dependent loans, had a carrying amount of $842,000, with a valuation allowance of $278,000, resulting in a
decrease of specific allocations within the provision for loan losses of $2.1 million for the year ending December 31, 2014.
2 OREO is measured at the lower of carrying or fair value less costs to sell, and had a net carrying amount of $32.0 million, which is
made up of the outstanding balance of $53.0 million, net of a valuation allowance of $19.2 million and participations of
$1.8 million, at December 31, 2014.
The Company also has assets that under certain conditions are subject to measurement at fair value on a nonrecurring basis. These
assets include OREO and impaired loans. The Company has estimated the fair values of these assets based primarily on Level 3 inputs.
OREO and impaired loans are generally valued using the fair value of collateral provided by third party appraisals. These valuations
include assumptions related to cash flow projections, discount rates, and recent comparable sales. The numerical range of unobservable
inputs for these valuation assumptions are not meaningful.
Note 18: Fair Values of Financial Instruments
The estimated fair values approximate carrying amount for all items except those described in the following table. Investment security
fair values are based upon market prices or dealer quotes, and if no such information is available, on the rate and term of the security.
The carrying value of FHLBC stock approximates fair value as the stock is nonmarketable and can only be sold to the FHLBC or
another member institution at par. During the years ended December 31, 2015, and 2014, the Company participated in redemptions and
a purchase with the FHLBC and, using these transactions values as the carrying value, FHLBC stock is carried at a Level 2 fair value.
Fair values of loans were estimated for portfolios of loans with similar financial characteristics, such as type and fixed or variable
interest rate terms. Cash flows were discounted using current rates at which similar loans would be made to borrowers with similar
ratings and for similar maturities. The fair value of time deposits is estimated using discounted future cash flows at current rates
offered for deposits of similar remaining maturities. The fair values of borrowings were estimated based on interest rates available to
the Company for debt with similar terms and remaining maturities. The fair value of off balance sheet volume is not considered
material. The fair value of mortgage banking derivatives is discussed above in Note 16.
79
The carrying amount and estimated fair values of financial instruments were as follows:
Financial assets:
Cash and due from banks
Interest bearing deposits with financial
institutions
Securities available-for-sale
Securities held-to-maturity
FHLBC and Reserve Bank Stock
Bank-owned life insurance
Loans held-for-sale
Loans, net
Accrued interest receivable
Financial liabilities:
Noninterest bearing deposits
Interest bearing deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Subordinated debenture
Note payable and other borrowings
Interest rate swap agreements
Borrowing interest payable
Deposit interest payable
Carrying
Amount
Fair
Value
Level 1
Level 2
Level 3
December 31, 2015
$
26,975
$
26,975
$
26,975
$
-
$
-
13,363
456,066
247,746
8,518
58,028
2,849
1,117,492
4,464
442,639
1,316,447
34,070
15,000
58,378
45,000
500
631
75
445
$
13,363
456,066
251,675
8,518
58,028
2,849
1,126,959
4,464
13,363
1,509
-
-
-
-
-
-
-
454,446
251,675
8,518
58,028
2,849
-
4,464
-
111
-
-
-
-
1,126,959
-
$
$
442,639
1,316,550
34,070
15,000
54,686
41,101
445
631
75
445
$
442,639
-
-
-
32,441
-
-
-
-
$
-
1,316,550
34,070
15,000
22,245
41,101
445
631
75
445
-
-
-
-
-
-
-
-
-
Carrying
Amount
Fair
Value
Level 1
Level 2
Level 3
December 31, 2014
Financial assets:
$
Cash and due from banks
Interest bearing deposits with financial institutions
Securities available-for-sale
Securities held-to-maturity
FHLBC and Reserve Bank Stock
Bank-owned life insurance
Loans held-for-sale
Loans, net
Accrued interest receivable
30,101
14,096
385,486
259,670
9,058
56,807
5,072
1,137,695
4,888
$
30,101
14,096
385,486
263,266
9,058
56,807
5,072
1,151,223
4,888
Financial liabilities:
Noninterest bearing deposits
Interest bearing deposits
Securities sold under repurchase agreements
Other short-term borrowings
Junior subordinated debentures
Subordinated debenture
Note payable and other borrowings
Borrowing interest payable
Deposit interest payable
$
400,447
1,284,608
21,036
45,000
58,378
45,000
500
75
467
$
400,447
1,284,887
21,036
45,000
54,686
39,366
422
75
467
$
$
30,101
14,096
1,527
-
-
-
-
-
-
$
-
-
330,900
263,266
9,058
56,807
5,072
-
4,888
$
-
-
53,059
-
-
-
-
1,151,223
-
$
400,447
-
-
-
32,441
-
-
-
-
$
-
1,284,887
21,036
45,000
22,245
39,366
422
75
467
-
-
-
-
-
-
-
-
-
Note 19: Financial Instruments with Off-Balance Sheet Risk and Derivative Transactions
To meet the financing needs of its customers, the Bank, as a subsidiary of the Company, is a party to various financial instruments with
off-balance-sheet risk in the normal course of business. These off-balance-sheet financial instruments include commitments to
originate and sell loans as well as financial standby, performance standby and commercial letters of credit. The instruments involve, to
varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The
Bank’s exposure to credit loss for loan commitments and letters of credit is represented by the dollar amount of those instruments.
80
Management generally uses the same credit policies and collateral requirements in making commitments and conditional obligations as
it does for on-balance-sheet instruments.
Interest Rate Swap Designated as a Cash Flow Hedge
The Company entered into a forward starting interest rate swap on August 18, 2015, with an effective date of June 15, 2017. This
transaction had a notional amount totaling $25.8 million as of December 31, 2015, was designated as a cash flow hedge of certain
junior subordinated debentures and was determined to be fully effective during the period presented. As such, no amount of
ineffectiveness has been included in net income. Therefore, the aggregate fair value of the swap is recorded in other liabilities with
changes in fair value recorded in other comprehensive income, net of tax. The amount included in other comprehensive income would
be reclassified to current earnings should all or a portion of the hedge no longer be considered effective. The Company expects the
hedge to remain fully effective during the remaining term of the swap. The Bank will pay the counterparty a fixed rate and receive a
floating rate based on three month LIBOR. Management concluded that it would be advantageous to enter into this transaction given
that the Company has trust preferred securities that will change from fixed rate to floating rate on June 15, 2017. The cash flow hedge
has a maturity date of June 15, 2037.
Summary information about the interest rate swap designated as a cash flow hedge is as follows:
Notional amount
Unrealized loss
Interest Rate Swaps
As of
December 31, 2015 December 31, 2014
$
25,774
(631)
$
-
-
The Bank also has interest rate derivative positions to assist with risk management that are not designated as hedging instruments.
These derivative positions relate to transactions in which the Bank enters an interest rate swap with a client while at the same time
entering into an offsetting interest rate swap with another financial institution. Due to financial covenant violations relating to
nonperforming loans, the Bank had $2.4 million in investment securities pledged to support interest rate swap activity with two
correspondent financial institutions at December 31, 2015. The Bank had $3.0 million in investment securities pledged to support
interest rate swap activity with three correspondent financial institutions at December 31, 2014.
In connection with each transaction, the Bank agreed to pay interest to the client on a notional amount at a variable interest rate and
receive interest from the client on the same notional amount at a fixed interest rate. At the same time, the Bank agreed to pay another
financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same
notional amount. The transaction allows the client to convert a variable rate loan to a fixed rate loan and is part of the Company’s
interest rate risk management strategy. Because the Bank acts as an intermediary for the client, changes in the fair value of the
underlying derivative contracts offset each other and do not generally affect the results of operations. At December 31, 2015, the
notional amount of non-hedging interest rate swaps was $20.7 million with a weighted average maturity of 5.1 years. At
December 31, 2014, the notional amount of non-hedging interest rate swaps was $16.3 million with a weighted average maturity of
2.7 years. The Bank offsets derivative assets and liabilities that are subject to a master netting arrangement.
The Bank also grants mortgage loan interest rate lock commitments to borrowers, subject to normal loan underwriting standards. The
interest rate risk associated with these loan interest rate lock commitments is managed with contracts for future deliveries of loans as
well as selling forward mortgage-backed securities contracts. Loan interest rate lock commitments generally have fixed expiration
dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Commitments to originate
residential mortgage loans held-for-sale and forward commitments to sell residential mortgage loans or forward MBS contracts are
considered derivative instruments and changes in the fair value are recorded to mortgage banking revenue. Fair values are estimated
based on observable changes in mortgage interest rates including mortgage-backed securities prices from the date of the commitment.
81
The following table presents derivatives not designated as hedging instruments as of December 31, 2015, and periodic changes in the
values of the interest rate swaps are reported in other noninterest income. Periodic changes in the value of the forward contracts related
to mortgage loan origination are reported in the net gain on sales of mortgage loans.
Asset Derivatives
Liability Derivatives
Interest rate swap contracts
Commitments1
Forward contracts2
Total
Notional or
Contractual Balance Sheet
Amount
$
Location
20,708 Other Assets
226,346 Other Assets
15,500 N/A
Fair Value
$
Balance Sheet
Location
114 Other Liabilities $
188 N/A
- Other Liabilities
$
302
Fair Value
114
-
-
114
$
1
2
Includes unused loan commitments and interest rate lock commitments.
Includes forward MBS contracts and forward loan contracts.
The following table presents derivatives not designated as hedging instruments as of December 31, 2014.
Asset Derivatives
Liability Derivatives
Interest rate swap contracts net of credit valuation
Commitments1
Forward contracts2
Total
Notional or
Contractual Balance Sheet
Amount
$
Location
16,334 Other Assets
201,946 Other Assets
14,000 N/A
Balance Sheet
Location
Fair Value
$
30 Other Liabilities $
143 N/A
- Other Liabilities
$
173
Fair Value
30
-
-
30
$
1
2
Includes unused loan commitments and interest rate lock commitments.
Includes forward MBS contracts.
Note 20: Preferred Stock
The Series B Stock was issued as part of the Treasury’s Troubled Asset Relief Program and Capital Purchase Program ( the “CPP”).
The Series B Stock qualifies as Tier 1 capital and pays cumulative dividends on the liquidation preference amount on a quarterly basis
at a rate of 5% per annum for the first five years, and 9% per annum thereafter effective in February 2014. Concurrent with issuing the
Series B Stock, the Company issued to the Treasury a ten year warrant to purchase 815,339 shares of the Company’s common stock at
an exercise price of $13.43 per share.
Subsequent to the Company’s receipt of the $73.0 million in proceeds from the Treasury in the first quarter of 2009, the Company
allocated the proceeds between the Series B Stock and the warrant that was issued. The Company recorded the warrant as equity, and
the allocation was based on their relative fair values in accordance with accounting guidance. The fair value was determined for both
the Series B Stock and the warrant as part of the allocation process in the amounts of $68.2 million and $4.8 million, respectively.
In the second quarter of 2014, the Company completed redemption of 25,669 shares of its Series B Stock at a price equal to 94.75% of
liquidation value or $24.3 million (including $1.4 million to Company Directors) provided that the holders of shares entered into
agreements to forebear payment of dividends due and to waive any rights to such dividends upon redemption. The Company redeemed
15,778 shares of its Series B Stock in the first quarter of 2015 and the remaining 31,553 shares of its Series B Stock in the third quarter
of 2015. During the year ending December 31, 2015 and 2014, the Company paid $2.4 million and $12.4 million in dividends on the
Series B Stock, respectively. At December 31, 2015, the Company has fully redeemed the Series B Stock. At December 31, 2014, the
Company carried $47.3 million of Series B Stock in total stockholders’ equity.
82
Note 21: Parent Company Condensed Financial Information
Condensed Balance Sheets as of December 31 were as follows:
Assets
Noninterest bearing deposit with bank subsidiary
Investment in subsidiaries
Other assets
Liabilities and Stockholders’ Equity
Junior subordinated debentures
Subordinated debt
Other liabilities
Stockholders’ equity
Condensed Statements of Income for the years ended December 31 were as follows:
Operating Income
Cash dividends received from subsidiaries
Other income
Operating Expenses
Junior subordinated debentures interest expense
Subordinated debt interest expense
Other interest expense
Other expenses
Loss before income taxes and equity in undistributed net income of subsidiaries
Income tax benefit
(Loss) income before equity in undistributed net income of subsidiaries
Equity in (over distributed) undistributed net income of subsidiaries
Net income
Preferred stock dividends and accretion of discount
Dividends waived upon preferred stock redemption
Gain on redemption of preferred stock
Net income available to common stockholders
2015
2014
$
33,500 $
204,509
22,951
$
260,960 $
7,059
272,285
19,940
299,284
$
$
58,378 $
45,000
1,653
155,929
260,960 $
58,378
45,000
1,743
194,163
299,284
2015
2014
2013
$
82,777 $
131
82,908
- $
231
231
-
772
772
4,287
814
7
1,978
7,086
75,822
(2,771)
78,593
(63,208)
15,385
1,873
-
-
13,512 $
4,919
792
16
1,045
6,772
(6,541)
(2,305)
(4,236)
14,372
10,136
5,062
(5,433)
(1,348)
11,855 $
5,298
811
16
1,006
7,131
(6,359)
(17,133)
10,774
71,311
82,085
5,258
-
-
76,827
$
83
Condensed Statements of Cash Flows for the years ended December 31 were as follows:
Cash Flows from Operating Activities
Net Income
Adjustments to reconcile net income (loss) to net cash from operating activities:
Equity in over distributed (undistributed) net income of subsidiaries
Deferred income taxes
Change in taxes payable
Change in other assets
Gain on recapture of restricted stock
Stock-based compensation
Other, net
Net cash used in operating activities
Cash Flows from Investing Activities
Net cash provided by investing activities
Cash Flows from Financing Activities
Divided paid
Purchases of treasury stock
Proceeds from the issuance of common stock
Redemption of preferred stock
Net cash provided by (used in) financing activities
Net change in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Note 22: Employee Benefit Plans
2015
2014
2013
$
15,385
$
10,136
$
82,085
63,208
(2,806)
(199)
83
-
613
22
76,306
(14,372)
(2,256)
22
740
-
295
(17,151)
(22,586)
(71,311)
(16,786)
14
(264)
(612)
167
5,502
(1,205)
-
-
-
(2,417)
(117)
-
(47,331)
(49,865)
26,441
7,059
33,500
$
(12,390)
(46)
64,331
(24,321)
27,574
4,988
2,071
7,059
$
$
-
(278)
-
-
(278)
(1,483)
3,554
2,071
Old Second Bancorp, Inc. Employees 401(k) Savings Plan and Trust
The Company sponsors a qualified, tax-exempt defined contribution plan (the “Plan”) qualifying under section 401(k) of the Internal
Revenue Code. Virtually all employees are eligible to participate after meeting certain age and service requirements. Eligible
employees are permitted to contribute up to a dollar limit set by law of their compensation to the Plan. For the years ended
December 31, 2015, 2014 and 2013, a discretionary match equal to 100% of the first 2% of the participant’s compensation was
contributed to participants of the Plan. Participants are 100% vested in the discretionary matching contributions. The profit sharing
portion of the Plan arrangement provides an annual discretionary contribution to the retirement account of each employee based in part
on the Company’s profitability in a given year, and on each participant’s annual compensation. Participants can choose between
several different investment options under the Plan, including shares of the Company’s common stock.
The total expense relating to the Plan was approximately $464,000, $477,000 and $468,000 in 2015, 2014 and 2013, respectively.
Old Second Bancorp, Inc. Voluntary Deferred Compensation Plan for Executives
The Company sponsors an executive deferred compensation plan, which is a means by which certain executives may voluntarily defer a
portion of their salary or bonus. This plan is an unfunded, nonqualified deferred compensation arrangement. Company obligations
under this arrangement as of December 31, 2015, 2014 and 2013 were $1.6 million, $1.9 million and $1.8 million, respectively, and are
included in other liabilities.
84
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Old Second Bancorp, Inc. and Subsidiaries
Aurora, Illinois
We have audited the accompanying consolidated balance sheet of Old Second Bancorp, Inc. and
Subsidiaries (the “Company”) as of December 31, 2015 and 2014, and the related consolidated
statements of income, comprehensive income, stockholders’ equity, and cash flows for each of
the three years in the period ended December 31, 2015. The Company’s management is
responsible for these consolidated financial statements. Our responsibility is to express an opinion
on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the consolidated financial statements are free of
material misstatement. Our audits included examining, on a test basis, evidence supporting the
amounts and disclosures in the consolidated financial statements, assessing the accounting
principles used and significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material
respects, the financial position of Old Second Bancorp, Inc. and Subsidiaries as of December 31,
2015 and 2014, and the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2015, in conformity with accounting principles generally
accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Old Second Bancorp, Inc. and Subsidiaries’ internal control over
financial reporting as of December 31, 2015, based on criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated March 10, 2016, expressed an unqualified opinion thereon.
Chicago, Illinois
March 10, 2016
85
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Company’s
disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as
amended, as of December 31, 2015. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that
as of December 31, 2015, the Company’s disclosure controls and procedures are effective to ensure that information required to be
disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized, and reported within the time periods specified in the SEC’s rules and forms and such information is accumulated and
communicated to the issuer’s management, including its principal executive and principal financial officers as appropriate to allow
timely decisions regarding required disclosure.
There were no changes in the Company’s internal control over financial reporting during the quarter ended December 31, 2015, that
have materially affected or are reasonably likely to affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as
defined in Rule 13a–15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is a
process designed under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external
reporting purposes in accordance with U.S. generally accepted accounting principles.
As of December 31, 2015, management assessed the effectiveness of the Company’s internal control over financial reporting based on
the framework established in the “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO). Based on this evaluation, management has determined that the Company’s internal control over
financial reporting was effective as of December 31, 2015, based on the criteria specified.
Plante & Moran PLLC, the independent registered public accounting firm that audited the consolidated financial statements of the
Company incorporated by reference to this Annual Report on Form 10-K, has issued an attestation report, included herein, on the
Company’s internal control over financial reporting as of December 31, 2015.
86
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Old Second Bancorp, Inc. and Subsidiaries
Aurora, Illinois
We have audited Old Second Bancorp, Inc. and Subsidiaries’ internal control over financial reporting as of
December 31, 2015, based on criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (referred to as “COSO”). Old
Second Bancorp, Inc. and Subsidiaries’ management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of internal control over financial
reporting included in the accompanying “Management’s Report on Internal Control Over Financial
Reporting.” Our responsibility is to express an opinion on Old Second Bancorp, Inc. and Subsidiaries’
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether effective internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation
of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on
the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, Old Second Bancorp, Inc. and Subsidiaries maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2015, based on criteria established in Internal
Control - Integrated Framework issued by COSO.
87
To the Board of Directors and Stockholders
Old Second Bancorp, Inc. and Subsidiaries
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), the consolidated balance sheet of Old Second Bancorp, Inc. and Subsidiaries as of
December 31, 2015 and the related consolidated statements of income, comprehensive income, changes in
stockholders’ equity, and cash flows for the year then ended, and our report dated March 10, 2016 expressed
an unqualified opinion on those financial statements.
Chicago, Illinois
March 10, 2016
88
Item 9B. Other Information
On March 9, 2016, the Company amended its Certificate of Incorporation to eliminate all references to the Company’s Fixed Rate
Cumulative Perpetual Preferred Stock, Series B (the “Series B Stock”), since no shares of the Series B Stock remained outstanding, or
would be issued in the future, following the redemption of all outstanding shares of Series B Stock in August 2015. A copy of the
Company’s Certificate of Incorporation reflecting this amended is filed with this Annual Report on Form 10-K as Exhibit 3.1.
In addition, on March 9, 2016, the Company’s board of directors amended the Company’s bylaws to (i) restore the right of the
Company’s stockholders to call a special meeting upon the written request of stockholders owning at least 50% of the shares of the
Company issued and outstanding and entitled to vote, (ii) adopt a majority voting standard for the election of directors, with a plurality
standard in the case of contested elections, and (iii) restore the right of the Company’s stockholders to, in the event the directors in
office at the time of the creation of any vacancy on the board of directors constitute less than a majority of the entire board of directors,
petition the Court of Chancery to order an election of directors to fill such vacancies. A copy of the Company’s Amended and Restated
Bylaws reflecting this amendment is filed with this Annual Report on Form 10-K as Exhibit 3.2.
Item 10. Directors, Executive Officers and Corporate Governance
PART III
The Company incorporates by reference the information required by Item 10 that is contained in the Proxy Statement for the 2016
Annual Meeting of Stockholders as filed April 15, 2016, or form DEF 14A. Such information shall be deemed “filed” with this Form
10-K
Executive Officers of the Registrant and Subsidiary
Name, Age and Year
Became Executive Officer
of the Registrant
Positions with Registrant
James L. Eccher
Age 50; 2005
President and Chief Executive Officer of the Company and the Bank; formerly President and Chief
Executive Officer of the Bank.
J. Douglas Cheatham
Age 59; 1999
Chief Financial Officer of the Company
Executive Vice President
Other information required by this Item is incorporated by reference from the information contained under the proposal “Election of
Directors,” and the headings “Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance,” and from the paragraph
regarding the Company’s Code of Business Conduct and Ethics under the heading “Corporate Governance and the Board of Directors”
in the proxy statement for our 2016 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2014
(the “Proxy Statement”).
Item 11. Executive Compensation
The Company incorporates by reference the information required by Item 11 that is contained in the Proxy Statement under the
captions “Compensation Discussion and Analysis,” “Board’s Role in Risk Oversight,” “Compensation Committee Interlocks and
Insider Participation,” and “Director Compensation.”
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The table below sets forth the following information as of December 31, 2015 for (i) all equity compensation plans previously
approved by the Company’s stockholders and (ii) all equity compensation plans not previously approved by the Company’s
stockholders:
(a) the number of securities to be issued upon the exercise of outstanding options, warrants and rights;
(b) the weighted-average exercise price of such outstanding options, warrants and rights;
(c) other than securities to be issued upon the exercise of such outstanding options, warrants and rights, the number of
securities remaining available for future issuance under the plans.
89
EQUITY COMPENSATION PLAN INFORMATION
Weighted-
Plan category
Equity compensation plans approved by security holders
Equity compensation plans not approved by security holders
Total
Number of securities average exercise
to be issued upon the
exercise of
outstanding options
162,500
-
162,500
price of
outstanding
options
27.03
-
27.03
$
$
Number of
securities remaining
available for future
issuance
125,000
-
125,000
The Company incorporates by reference the other information that is required by this Item 12 that is contained in the Proxy Statement
under the caption “Security Ownership of Certain Beneficial Owners and Management.”
Item 13. Certain Relationships and Related Transactions, and Director Independence
The Company incorporates by reference the information that is required by this Item 13 that is contained in the Proxy Statement under
the captions “Corporate Governance and the Board of Directors” and “Transactions with Management.”
Item 14. Principal Accountant Fees and Services
The Company incorporates by reference the information required by this Item 14 that is contained in the Proxy Statement under the
caption “Ratification of Our Independent Registered Public Accountants.”
PART IV
Item 15. Exhibits and Financial Statement Schedules
(1) Index to Financial Statements: See Part II--Item 8. Financial Statements and Supplementary Data.
(2) Financial Statement Schedules
All financial statement schedules as required by Item 8 of Form 10-K have been omitted because the information requested is
either not applicable or has been included in the consolidated financial statements or notes thereto.
(3) Exhibits: See Exhibit Index.
90
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
SIGNATURES
OLD SECOND BANCORP, INC.
BY:
/s/ James L. Eccher
James L. Eccher
President and Chief Executive Officer
DATE: March 11, 2016
91
SIGNATURES (Continued)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ William B. Skoglund
William B. Skoglund
/s/ James L. Eccher
James L. Eccher
/s/ J. Douglas Cheatham
J. Douglas Cheatham
/s/ Edward Bonifas
Edward Bonifas
/s/ Barry Finn
Barry Finn
/s/ William Kane
William Kane
/s/ John Ladowicz
John Ladowicz
/s/ Duane Suits
Duane Suits
/s/ James F. Tapscott
James F. Tapscott
/s/ Patti Temple Rocks
Patti Temple Rocks
Chairman of the Board, Director
March 11, 2016
President and Chief Executive Officer
Old Second Bancorp and Old Second National
Bank (principal executive officer)
March 11, 2016
March 11, 2016
March 11, 2016
March 11, 2016
March 11, 2016
March 11, 2016
March 11, 2016
March 11, 2016
March 11, 2016
Executive Vice President and
Chief Financial Officer, Director
(principal financial and accounting officer)
Director
Director
Director
Director
Director
Director
Director
92
Exhibits:
EXHIBIT
NO.
EXHIBIT INDEX
Description of Exhibits
3.1
Restated Certificate of Incorporation of Old Second Bancorp, Inc.
3.2
Amended and Restated Bylaws of Old Second Bancorp, Inc.
4.1
4.2
4.3
4.4
4.5
4.6
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
Amended and Restated Rights Agreement and Tax Benefits Preservation Plan, dated September 12, 2012 (incorporated herein by
reference to Exhibit 99.1 of Form 8-K filed by Old Second Bancorp, Inc., September 13, 2012).
First Amendment to Amended and Restated Rights Agreement and Tax Benefits Preservation Plan, dated April 3, 2014
(incorporated herein by reference to Exhibit 10.2 of Form 10-Q filed on August 13, 2014).
Second Amendment to Amended and Restated Rights Agreement and Tax Benefits Preservation Plan, dated as of September 2,
2015 (incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K filed on September 4, 2015)
Form of Stock Certificate for Series B Fixed Rate Cumulative Perpetual Preferred Stock (incorporated by reference to Exhibit 4.1 of
the Company’s Form 8-K filed by Old Second Bancorp, Inc. on January 16, 2009).
Warrant to Purchase Shares of Common Stock, dated January 16, 2009 (incorporated herein by reference to Exhibit 4.2 of the
Company’s Form 8-K filed on January 16, 2009).
Specimen Common Stock Certificate of Old Second Bancorp, Inc. (incorporated herein by reference to Exhibit 4.1 of the
Company’s Form S-1 filed on January 17, 2014).
Form of Compensation and Benefits Assurance Agreements for the executive officers (filed as Exhibit 10.1 to the Company’s
Form 10-Q filed on November 8, 2006 and incorporated herein by reference).
Old Second Bancorp, Inc. Employees 401 (k) Savings Plan and Trust (filed with the Company’s Form S-8 filed on June 9, 2000 and
incorporated herein by reference).
Form of Indenture relating to trust preferred securities (filed as Exhibit 4.1 to the Company’s registration statement on the
Company’s Form S-3 filed on May 20, 2003 and incorporated herein by reference).
Indenture between Old Second Bancorp, Inc. as issuer, and Wells Fargo Bank, National Association, as Trustee, dated as of
April 30, 2007 (filed as exhibit 99 (b) (2) to the Company’s Amendment No. 1 to Schedule TO filed on May 2, 2007 and
incorporated herein by reference and incorporated herein by reference).
Old Second Bancorp, Inc. 2008 Long Term Incentive Plan (filed as Appendix A to the Company’s Form DEF14A filed on
March 17, 2008 and incorporated herein by reference).
Employment Agreement, dated September 15, 2014, by and among Old Second Bancorp, Inc. and James L. Eccher (filed as
Exhibit 10.1 to the Company’s Form 8-K filed on September 18, 2014 and incorporated herein by reference).
Amended and Restated Voluntary Deferred Compensation Plan for Executives and Directors (filed as an Exhibit to the Company’s
Form 8-K filed on March 28, 2005 and incorporated herein by reference).
Amendment to the Old Second Bancorp, Inc. Supplemental Executive and Retirement Plan (filed as Exhibit 10.1 to the Company’s
Form 8-K filed on October 24, 2005 and incorporated herein by reference).
Form of Amended Stock Option Award Agreement (filed as Exhibit 10.1 to the Company’s Form 8-K filed on December 21, 2005
and incorporated herein by reference).
93
10.10
10.11
10.12
Loan and Subordinated Debenture Purchase Agreement, dated January 31, 2008, between LaSalle Bank National Association (now
Bank of America) and Old Second Bancorp, Inc. (filed as Exhibit 10.11 to the Company’s Form 10-K filed on March 17, 2008 and
incorporated herein by reference).
Agreed Upon Terms and Procedures, dated January 31, 2008, between LaSalle Bank National Association (now Bank of America)
and Old Second Bancorp, Inc. (filed as Exhibit 10.12 to the Company’s Form 10-K filed on March 17, 2008 and incorporated herein
by reference).
Letter Agreement, dated January 16, 2009, by and between Old Second Bancorp, Inc., and the United States Department of the
Treasury, which includes the Securities Purchase Agreement – Standard Terms with respect to the issuance and sale of the Series B
Stock and the Warrant (filed as Exhibit 10.1 to the Company’s Form 8-K filed on January 16, 2009 and incorporated herein by
reference).
10.13
2008 Equity Incentive Plan Restricted Stock Award Agreement (filed as Exhibit 10.1 to the Company’s Form 8-K filed on
February 23, 2009 and incorporated herein by reference).
10.14
2008 Equity Incentive Plan Restricted Stock Unit Award Agreement (filed as Exhibit 10.2 to the Company’s Form 8-K filed on
February 23, 2009 and incorporated herein by reference).
10.15
2008 Equity Incentive Plan Incentive Stock Option (filed as Exhibit 10.3 to the Company’s Form 8-K filed on February 23, 2009
and incorporated herein by reference).
10.16
2008 Equity Incentive Plan Incentive Non-Qualified Stock Option (filed as Exhibit 10.4 to the Company’s Form 8-K filed on
February 23, 2009 and incorporated herein by reference).
10.17
Old Second Bancorp, Inc. 2014 Equity Incentive Plan (incorporated herein by reference to Appendix A to the Company’s definitive
proxy statement on Form DEF14A filed on April 21, 2014).
10.18
First Amendment to the Old Second Bancorp, Inc. 2014 Equity Incentive Plan.
21.1
A list of all subsidiaries of the Company (filed herewith).
23.1
Consent of Plante & Moran, PLLC (filed herewith).
31.1
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).
31.2
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).
32.1
32.2
101
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002 (filed herewith).
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002 (filed herewith).
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets at December 31, 2015, and
December 31, 2014; (ii) Consolidated Statements of Income for year ended December 31, 2015, 2014 and 2013; (iii) Consolidated
Statements of Stockholders’ Equity for the twelve months ended December 31, 2015, 2014 and 2013; (iv) Consolidated Statements
of Cash Flows for the twelve months ended ; and (v) Notes to Consolidated Financial Statements, tagged as blocks of text and in
detail.*
94
Old Second Bancorp, Inc. and
Old Second National Bank Directors
William Skoglund
Chairman,
Old Second Bancorp, Inc. &
Old Second National Bank
James Eccher
CEO & President
Old Second Bancorp, Inc. &
Old Second National Bank
John Ladowicz
Former Chairman & CEO,
HeritageBanc Inc. & Heritage Bank
Duane Suits
Retired Partner, Sikich LLP
James Tapscott
Retired Partner, McGladery LLP
J. Douglas Cheatham
Executive Vice President & Chief Financial Officer,
Old Second Bancorp, Inc.
Patti Temple Rocks
Managing Director, GOLIN
Edward Bonifas
Vice President, Alarm Detection Systems, Inc.
Barry Finn
President & CEO, Rush-Copley
Medical Center
William Kane
General Partner,
The Label Printers, Inc.
Gerald Palmer
Senior Director, Old Second Bancorp, Inc.
Director, Old Second National Bank
Retired, Vice President & General Manager,
Caterpillar, Inc.
Member FDIC
95
90
Marengo
MCHENRY
23
Huntley
Crystal
Lake
14
Lake-in-the-Hills
Algonquin
Carpentersville
LAKE
Lake
Zurich
22
94
45
Genoa
23
Hampshire
Burlington
72
Pingree
Grove
Sleepy
Hollow
47
20
Elgin
Sycamore
DeKalb
KANE
Wasco
Maple Park
38
DEKALB
Hinckley
30
23
Elburn
88
Geneva
25
Kaneville
Batavia
31
N. Aurora
Sugar Grove
Big Rock
Aurora
30
Montgomery
59
Hoffman
Estates
90
Arlington
Heights
94
294
Schaumburg
290
St. Charles
64
W. Chicago
20
290
Carol
Stream
355
Winfield
DUPAGE
Wheaton
56
Warrenville
Downers
Grove
Oak
Brook
Lisle
34
Naperville
Bolingbrook
55
COOK
Oak Park
290
45
20
294
90
94
Plano
34
Yorkville
Oswego
30
59
Sandwich
KENDALL
Plainfield
47
Oak
Lawn
90
94
57
Romeoville
53
Lockport
WILL
Joliet
45
Orland
Park
30
80
Mokena
94
80
71
LASALLE
23
Ottawa
Morris
80
Shorewood
Minooka
55
New
Lenox
Frankfort
Chicago
Heights
57
71
45
Peotone
GRUNDY
Old Second National Bank
37 S. River St., Aurora
555 Redwood Dr., Aurora
1350 N. Farnswor th Ave., Aurora
1230 N. Orchard Road, Aurora
4080 Fox Valley Ctr. Dr., Aurora
1991 W. Wilson St., Batavia
194 S. Main St., Burlington
195 W. Joe Orr Rd., Chicago Heights
749 N. Main St., Elburn
3290 Rt. 20, Elgin
20201 S. LaGrange Rd., Frankfor t
850 Essington Rd., Joliet
2S101 Har ter Rd., Kaneville
3101 Ogden Ave., Lisle
1100 S. County Line Rd., Maple Park
200 W. John St., Nor th Aurora
1200 Douglas Rd., Oswego
323 E. Norris Dr., Ottawa
7050 Burroughs Ave., Plano
801 S. Kirk Road, St. Charles
Route 47 @ Cross St., Sugar Grove
1810 DeKalb Ave., Sycamore
40W422 Route 64, Wasco
26 W. Countryside Pkwy., Yorkville
420 S. Bridge St., Yorkville
96
Member FDIC
Old Second Bancorp, Inc.
37 South River Street, Aurora, IL 60506-4173 • www.oldsecond.com • 1-877-866-0202